As 401k and 403b providers slowly, and sometimes reluctantly, begin to use data and technology to provider better retirement solutions to defined contribution (DC) plan sponsors and participants, the use of dynamically managed 401k accounts as the default option (QDIA) is being explored. But based on recent lawsuits, these managed 401k accounts may be ticking time bomb for DC plan sponsors if not managed and monitored properly.
Although target date funds (TDFs) have taken the DC industry by storm attracting over $800 billion and 60-70% of new contributions in their position as the most popular default option, the industry is questioning whether all investors born within five years of each other have the same goals. Isn’t data about the employee and even their behavior in combination with technology available to create more personalized portfolios?
For younger investors, the issue is more about deferring as much as possible but, as people get closer to retirement, the glide path and amount of risk taken becomes more important. Like with a pension or DB plan, risk needs to be taken commensurate with the need. For example, if an investor has enough to replace 50% or more of their income from their DC plan, why take too much risk assuming social security and other assets? The opposite is also true neither of which can be handled by TDFs.
So dynamically managed 401k accounts are being suggested as the default option using liability driven investing (LDI) principles common in DB plans because, in a sense, each investor is managing their own personal pension plan.
The issue with managed 401k accounts are twofold. What are the fees and, if higher than say TDFs, are they reasonable based on the value they deliver over a less costly option. Secondly, as we have learned with the lawsuits against the largest managed account provider, Financial Engines, record keepers receive kickbacks or product placement fees otherwise known as revenue sharing. Though not a per se violation, plan sponsors must determine whether the additional fees received from managed account providers like Financial Engines are reasonable for the services the record keeper provides to the plan and the participants.
Through the 2012 DOL rules 408b2 and 404a5, we have learned that disclosure is not enough – most plan sponsors and participants still do not understand revenue sharing and commissions never mind marketing incentives to distributors and other indirect fees. Which is why the DOL fiduciary rule seeks to eliminate most of the potential conflicts not just disclose them. Managed 401k accounts, though potentially valuable to some investors and likely to gain popularity must be treated like any other investment. Plan fiduciaries must ask this simple question: Are the fees reasonable for the value received, including revenue sharing paid to service providers?
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