As the American workforce has come to depend increasingly on defined contribution (DC) plans for retirement, the approach to investing those retirement savings has evolved.
Initially, DC plan participants were left to fend for themselves. As the challenges of investing became apparent—in particular, investing’s behavioral pitfalls—the landscape shifted toward risk-based portfolios.
These portfolios allowed participants to choose from a few diversified portfolios, each of which had a static target level of expected risk and return. But participants still had to deliberately move toward more conservative portfolios over time.
The next step—target date portfolios—alleviated participants of that responsibility. Target date portfolios enable participants to choose from a set of portfolios that are assigned target retirement years. Over time, each portfolio’s composition changes to target decreasing levels of risk.
The common thread throughout the decades-long transition is the removal of portfolio construction responsibility from participants, however; even participants with access to target date portfolios must choose one.
They also must decide how much to save, when to retire, and how much to withdraw during retirement.
Despite many advantages, even target date portfolios rarely satisfy the needs of every plan participant.
Given a plan sponsor’s fiduciary duties to the entire plan, what option can they make available for these participants requiring more assistance?
Managed accounts may be a good solution. Many recordkeepers offer a managed account service to plan sponsors.
Participants can enroll in managed accounts, which allow for personalized portfolio construction (taking outside assets into account), discretion to select a portfolio for the participant, and personalized advice including how much to save, when to retire, and how to take distributions during retirement.
Evaluating Managed Accounts
When evaluating if managed accounts are an appropriate option for a plan, a good place to begin is to see if the plan’s participants will benefit from the service.
One of the most beneficial services managed accounts can provide is to increase a participant’s savings rate. How well does your managed account service help increase savings rate?
The next question is whether participants would have assets outside of the plan that would contribute meaningfully to creating retirement income.
If not, then few will benefit from a managed account’s ability to consider outside assets when making investment decisions.
Plan sponsor clients should also see how effectively the platform gathers the participant-specific data to create a portfolio. If participants must take the initiative to provide and update this information, the quality of the resulting retirement advice is likely to suffer.
If the provider has a thoughtful, proactive way of maintaining up-to-date participant information, managed accounts should add value.
Additionally, plan sponsors should remember the simple comfort participants may enjoy in knowing that experts are making their investment decisions.
Next, plan sponsor clients should review the asset classes that can be included in the managed account portfolio, then the focus should turn to the method used to determine the mix of asset classes in portfolios.
Allocations are typically created using statistical assumptions for each asset class to combine them into efficient portfolios. They should also consider how frequently those assumptions are updated and portfolios are rebalanced. Because return projections are extremely imprecise over short periods of time, frequent changes and rebalances would be cause for concern.
Generally, updates to asset class assumptions and rebalances that occur at least annually, but no more frequently than quarterly, are appropriate.
Next, a plan sponsor should evaluate portfolio construction. A major consideration is whether the asset allocations are filled with funds from the existing plan menu or with the provider’s proprietary funds. Normally plan sponsors will prefer funds they have already approved for the menu, and they should be wary of a provider’s propriety funds.
They should also understand the analysis done on funds in the menu before they are used in portfolios. Some providers test the characteristics of funds in the menu for fit within respective asset classes, while others do not. In any case, plan sponsors ought to be comfortable with a provider’s portfolio construction methods.
Plan sponsors that allow unique characteristics, like ownership of employer stock, would want to evaluate how the managed account platform deals with these assets. Another unique characteristic might be an employer’s exemption from paying Social Security taxes.
These plan sponsors would want to ensure that a managed account would be able to reflect the absence of Social Security benefits when creating a participant’s saving and investment plan. Employers that also provide defined benefit plans or other defined contribution plans ought to ask how easily those benefits and assets can be included in developing participant-specific saving and investing advice.
Normally, managed account fees are paid by participants and are calculated as a percentage of the account’s market value. Most of the time fees decrease as the account size increases. The highest fee might be charged on all assets below $25,000 or $50,000 and the lowest fee charged on assets above a $400,000 or $500,000 threshold, with two or three breakpoints in between.
Plan sponsors should be aware of this structure because providers are often willing to negotiate these fee levels and breakpoints. Comparing the fee structures of the providers that suit their needs best can reveal opportunities to negotiate the best price for participants.
In conclusion, managed accounts might provide excellent value to some DC plan participants, while offering little to others. Plan sponsors ought to evaluate whether their participants are likely to benefit from managed accounts generally and whether specific platforms are likely to meet their needs. The considerations mentioned should be a good place to start in answering each of these questions.
Jared Martin, CFP, AIF is Vice President with Innovest Portfolio Solutions. For more than 20 years, Innovest has provided excellent client service as well as forward-looking, innovative investment solutions for endowments and foundations, retirement plans, and families. We are an independent provider of investment-related consulting services and work on a fee-only basis.