Thinking About Managed Accounts? Read This First
Thinking About Managed Accounts? Professionally managed accounts are being touted by 401(k) providers as the next best investment option since target date funds (TDFs). While they have their merits — they’re designed to provide more individually customized investment allocations and increase the likelihood that participants will have adequate income in retirement — a recent article from the Society for Human Resource Management (SHRM) points out they may not be a panacea.
Since the Pension Protection Act of 2006 introduced the safe harbor qualified default investment alternative (QDIA) provision, TDFs have been the go-to default solution for the majority of defined contribution (DC) plan sponsors. However, managed account proponents argue that TDFs are essentially a “one-size-fits-all” solution. That’s because TDFs all work basically the same way — the underlying model portfolios use a participants’ anticipated retirement date, shifting from more risky, growth-oriented equity allocations to a more conservative mix of bond assets as the participant nears retirement.
By contrast, managed accounts’ chief benefit is they offer greater portfolio customization than traditional TDFs. Managed accounts consider a much broader range of factors than TDFs, including deferral rates, age, salary, risk tolerance, current savings — in the plan, along with outside assets, if provided — spousal assets, estimated retirement income requirements, and more. All of that data is key to creating a customized asset allocation, but collecting that information can be challenging for plan sponsors and managed account providers, putting a potential crimp in determining the most appropriate investment mix.
Moreover, the fees for professionally managed accounts are higher than those for most TDFs — 0.10% to 0.80% more, according to The Wall Street Journal.
Does managed accounts’ performance justify the higher fees? The short answer is, it depends. The SHRM article cited several recent studies (some of which were conducted by managed account providers), which showed that participants enrolled in managed accounts earned on average 0.24% more per year after fees than those in TDFs. Participants in managed accounts also contributed 0.5% more annually than TDF users.
Enhanced through compounding, those relatively small percentages could add up significantly over time. The tradeoff is that some of that long-term value may be eroded by managed accounts’ higher fees.
Moreover, managed account uptake is minimal. Just 4% to 15% of plan sponsors — mostly larger plans — offer professionally managed accounts, and few have designated them as a QDIA. Among larger plan sponsors, 86% offered a professionally managed account as the QDIA last year. However, only a small percentage of participants opt in to managed accounts when they are offered.
The SHRM article cited Vanguard research corroborating these trends. Among Vanguard plans, 96% had TDFs as their QDIA, and 4% used balanced funds. Less than 1% of plans had selected a managed account.
One issue is that managed accounts are challenging to benchmark, whereas plan sponsors can gauge with relative ease whether a target date fund’s model allocation, glide path and performance are suitable based on participant demographics and behavior patterns. In doing extensive due diligence on their target date offerings, well-meaning plan sponsors may set a precedent for how the plan interprets and utilizes asset allocation advice, which may then be contradicted by their managed account provider, whose approach may be entirely different. From that perspective, adding a managed account to a plan’s investment lineup, or using one as a QDIA, can create complications.
All that said, plan sponsors who opt to offer professionally managed accounts should be intimately involved in the data collection process. Often, participants forget to provide key information, such as retirement plan account assets from former employers, or outside investments earmarked for their post-career years. Moreover, research shows that more than half of participants with a managed account choose not to engage with it even if they choose it, and even if they are paying higher fees for the added customization.
As such, communication is key to helping participants understand the importance of providing critical data and engaging with their managed account to get the most from it. A well-organized, strategic communication program that explains managed accounts’ value and how to maximize them can help improve participants’ understanding of and engagement with such offerings. Further, it’s important to follow-up and keep driving the message home to ensure successfully managed account uptake and consistent usage.
From a fiduciary perspective, sponsors should weigh their options when it comes to fees and choosing a provider, and ensure that they are getting fair value for their plan dollars. That also means doing proper, thorough due diligence when it comes to selecting a managed account provider and being able to show without a doubt that they have made the most prudent choice for participants.
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