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Weren't target-date funds supposed to be the one-stop solution for unsophisticated investors?
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updated on Nov. 27, 2017
Offering employees professionally managed accounts in a 401(k) plan might seem to be an excellent option, as this service seeks to provide an investment mix customized to individual needs and goals while increasing the odds of saving enough money for retirement.
That's the pitch more 401(k) management firms are aggressively selling to plan sponsors, and there's some truth to it. But managed accounts also present challenges and concerns that both plan sponsors and participants should fully understand.
What Are Managed Accounts?
Under a managed account option:
Plan sponsors should assess the value of a vendor's managed account services against the fees paid out of participants' accounts.
"The additional cost of managed accounts solutions can vary significantly by provider, from free to an annual fee exceeding 0.5 percent of portfolio assets," David Blanchett, head of retirement research for Chicago-based Morningstar Investment Management,
wrote in January. "For some participants, this fee may be well worth the costs; but you shouldn't assume that a more customized service will magically improve [the participants'] retirement picture."
[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement Plans]
Managed Accounts vs. Target-Date Funds
Target-date funds (TDFs), like managed accounts, were created to tailor account investments to a participant's needs, and for many years 401(k) service providers have marketed TDFs as the preferred "let us do it for you" solution. However, TDFs provide model portfolios based solely on participants' anticipated retirement dates, shifting assets from more-risky stock funds (which have greater long-term growth potential) to safer bond funds (which have more-modest overall returns) as participants get closer to their target retirement year.
Managed accounts, in contrast, take into consideration a wider range of factors, such as contribution rates, personal risk tolerance, current savings in individual retirement accounts (IRAs) or taxable accounts, and anticipated spending needs in retirement.
If managed accounts are to truly help participants prepare for retirement, the data and information they rely on to choose investments for participants must be as robust as possible. "This goes beyond account balance and age to include salary, mortality, match structure, gender [and] state of residence," said Jason Shapiro, senior investment consultant with Willis Towers Watson in New York City. "Additional information on outside investments, like IRAs, spousal assets, risk tolerance and retirement goals are also important."
Participants, however, pay for this higher level of personalization. The annual cost spread between managed accounts and TDFs is typically more than 0.5 percent,
noted Manning & Napier, an investment firm. Similarly,
The Wall Street Journal reported that managed accounts generally cost 0.10 percent to 0.80 percent more than TDFs.
How does the long-term performance of managed accounts compare to investing in age-appropriate TDFs?
The Wall Street Journal reported that recent studies—some conducted by firms that provide 401(k) managed account services—showed participants in managed accounts earned on average 0.24 percent more annually after fees than those in TDFs. Participants also chose to contribute 0.5 percent more annually than those in TDFs, presumably because they felt greater confidence about their investments. While those percentages seem small, over several decades and with the effect of compounding they could prove significant.
Others, however, remain skeptical about the long-term added value that managed accounts actually will provide, given their higher fees.
Report: Participants Often Misuse Target-Date Funds
A report published last year by Financial Engines, an investment advice firm based in Sunnyvale, Calif., found that:
TDFs are designed to hold all of an investor's plan assets in a single, diversified fund aligned with the investor's expected retirement date. ... However, prior research by Financial Engines and Aon Hewitt revealed that the majority (62 percent) of TDF users invest only part of their plan assets into their TDF. The same research study found that only 57 percent of people who started out with almost all of their assets invested in TDFs were still fully invested in TDFs five years later.
TDFs are designed to hold all of an investor's plan assets in a single, diversified fund aligned with the investor's expected retirement date. ... However, prior research by Financial Engines and Aon Hewitt revealed that the majority (62 percent) of TDF users invest only part of their plan assets into their TDF.
The same research study found that only 57 percent of people who started out with almost all of their assets invested in TDFs were still fully invested in TDFs five years later.
Current surveys find that only a fraction of plan sponsors—investment companies say from 4 percent to 15 percent of their clients and most of them larger plans—offer a managed account option. Few have made managed accounts their plan's qualified default investment alternative (QDIA) for participants who don't actively direct their own investments. In contrast, among larger plan sponsors, 86 percent offered TDFs as their QDIA last year. When managed accounts are made available through a plan, only a small percentage of participants choose to opt in to them.
Similarly, Vanguard Investments
reported that last year among its client plans designating a QDIA:
"Managed accounts, if used, can be great," said Jim Scheinberg, managing director of North Pier Fiduciary Management in Los Angeles. But "voluntary uptake among plan participants is low, with most plans seeing [participant selection rates] of 2 percent to 4 percent, and the highest I have seen is 10 percent."
Involvement Is Key
One problem when 401(k) account holders opt for managed accounts is getting participants to interface with the data and provide all necessary information to the account manager, Scheinberg said. For example, a participant may not think to tell the account manager about 401(k) plan balances in former employers' plans, IRAs or other assets they have earmarked for retirement. "The average participant has three retirement accounts," he said. "If the account manager is not plugging in that information, he or she can be giving improper advice" on how to invest for retirement.
Research by Willis Towers Watson shows that half of the plan participants using a managed account for their retirement assets are not engaging with the managed account platform even though they chose to use this option. "You would think that those who opt in to a managed account and are willing to pay any additional management fee involved would be the most likely to engage" with their accounts and advisors, Shapiro said.
Plan sponsors should
consider their fiduciary responsibilities when adding and reviewing managed accounts, wrote John Buckey, a consultant with Cammack Retirement Group in Wellesley, Mass.
For instance, they "must carefully reflect on their plan and participants to deem whether the option may truly lead to a more positive participant experience and better retirement outcomes," Buckey advised. They also should "consider how robust the managed account feature is and how complex is it for plan participants to fully engage with the program and to otherwise optimize their overall experience," he noted.
Employers should also consider the cost of managed accounts, particularly given the ongoing scrutiny of retirement plan fees.
"When you consider [managed account fees], the benefits of increased customization often can be eaten away by those increased costs," Scheinberg said, although choosing low-cost investments like index funds can help offset these fees.
Still, the additional expense, deducted from assets held in the account, makes some plan sponsors uneasy. "This is a fiduciary decision, so employers have to look at the value proposition, including whether there is a fair trade-off between fees paid and services provided," Shapiro said. "Providers may negotiate [managed account fees] on a client-by-client basis, but smaller employers generally have less negotiating power than larger employers."
Provider choice is another key fiduciary issue, Scheinberg said. In many cases, the existing 401(k) service provider proposes adding managed accounts, creating additional revenue for the firm. Given the closeness of the plan sponsor/service provider relationship and the relatively limited number of vendors capable of managing accounts for 401(k) or similar plans, it could be difficult for plan sponsors to definitively show that they have made the most prudent choice of managed account provider. That's especially true if a managed account option is added without evidence of due diligence, such as sending out requests for information or requests for proposals to competing firms.
Subsidizing the Service
To offset fee concerns, some advisors suggest that employers pay the managed account fees once a participant reaches a certain age, such as 55 or 60, and is preparing for retirement. Younger participants would have access to TDFs until they reach the stated age and then, if they don't opt out, be switched over to a managed account as they shift from accumulating retirement assets to determining how to turn those assets into a retirement income stream.
The Wall Street Journal reported that media giant Bertelsmann Inc. has adopted this approach.
Joanne Sammer is a New Jersey-based business and financial writer.
Related SHRM Article:
Do ‘Customized’ Target-Date Funds Hit the Target?,
SHRM Online Benefits, October 2014
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