Do you have a Managed Account Program as part of your 401k investment options? If not, you will probably hear about them soon. According to Vanguard's
How America Saves 2021: Insights to Action, about half of all 401(k) plans currently have access to a managed account program but most are in the mid-to-large plan space. However, small plan sponsors are quickly seeing the value of these services. So, what are managed accounts and how do they add value?
Managed accounts use a professional portfolio management service to make all the investment decisions for a participant’s 401(k) account. The service is automated and usually offered by a recordkeeper, but many outsource and bring in an independent managed account provider. In that case, the plan investment advisor provides the fund menu, education, and information on the service.
Although the above description is valid, the value of a managed account is in the details. In a 401(k) plan, managed accounts can be a Qualified Default Investment Alternative (QDIA), be set to provide income at a certain age, or used as an automated individual investment advisory tool. This article will concentrate on using managed accounts as an investment advisory tool for those individuals who do not want the responsibility of making investment decisions.
Managed accounts as an Investment Advisory Tool:
To understand the value of managed accounts, we must first explain what other investment options are available in most 401(k) plans. It is important to note that managed accounts are not another fund option. Instead, they are a fiduciary service that uses an individual’s unique data points to build a personalized allocation specific to their retirement needs. Often, the investments inside these allocations are the funds from the existing fund menu for the plan. Plan sponsors should still monitor the advisor who provides the fund menu as part of their fiduciary duty.
Below are the three competing options:
Do It Yourself-DIY 401(k) Savers:
These investors are putting themselves in the driver’s seat and taking responsibility for fund research, monitoring, diversification, allocation, and rebalancing. Although some DIY savers are successful, life gets in the way and the annual/quarterly/monthly investment overview just doesn’t get completed or is delayed. To make matters worse, allocations are seldom updated. This results in accounts that are both over/under diversified and have inappropriate risk for a participant's age or risk profile.
Many DIY investors underperform the market and therefore, often have poor retirement outcomes. Twenty-five years ago, this was the only option for most 401(k) participants. Plan sponsors and the investment community were clamoring for a better solution. Two competing solutions, Target Date funds and Risk Models, were then brought into plan menus to relieve participants of being both an investor and investment analyst.
Risk Models (Do It with Me) Investors:
401(k) participants are asked to determine their risk profile via a short questionnaire. The participants’ assets are then allocated to either a conservative, moderate, or aggressive model. Risk models use the plans current fund lineup as building blocks, but the allocation is based on just one data point - the participant's risk profile.
Once invested, the participant should be re-evaluating their risk level every few years as things may have changed in their professional or personal lives. Like DIY investors, this re-evaluation does not always happen, and the result is that a participant may have too much or too little risk as they age. However, risk models are a huge improvement over the DIY option and have improved outcomes for many investors.
Target Date Fund (Do It for Me) Investors:
Target Date funds (TDF’s) are probably the most successful option in terms of popularity and assets under management. This is due to the simplicity of TDF’s. According to Vanguard’s
How America Saves 2022, 95% of plans offered TDF’s in 2021, 81% of all plan participants use a target date fund, and 69% of all participants invested all their 401(k) assets solely in a TDF.
Like risk models, TDF’s base their allocation on one data point. In the case of TDF’s, it is the participants year of retirement. Each participants’ assets are placed in a target date fund that is closest to their retirement year (example: someone retiring in 2038 would use the 2040 TDF). Each target date fund is managed professionally and allocated separately by the selected investment management firm (Fidelity, Empower, BlackRock, T Rowe Price and Vanguard are all big providers of TDF solutions). As a participant gets older, the risk level automatically reduces the amount of assets in stock and increases the amount of bonds in the target date fund.
Target date funds are one of the best innovations to come out of the 401(k) industry. They are simple, as all you need to know is your retirement year. They automatically allocate and rebalance, and participants never need to make a change unless they prefer to move to a different strategy. They also can be very inexpensive if using a passive target date fund. However, TDF’s are not perfect and do have a few shortcomings such as:
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- Asset allocation in a particular TDF may not appropriately match the risk profile of the investor.
- Workers of similar age receive the same allocation despite different incomes, savings rates, account balances, and other key important retirement datapoints.
- TDF investors are significantly less likely to seek any form of investment advice and tend to not know of other critical issues as they near retirement.
- Participants enrolled in a TDF may move to a higher percentage of bonds earlier than needed, thus sacrificing asset growth.
Managed Account Programs: Managed accounts solve many of the problems discussed above and add additional value for plan sponsors, participants, and investment advisors. The main difference between DIY, Risk Models, and Target Dates may be explained in one word: personalization. Personalization is the “buzz word” in the employee benefits world these days and managed accounts are a big part of this trend. Managed accounts address the individual’s need for appropriate asset allocation and increased diversification.
Unlike TDF’s and Risk Models, Managed accounts look at multiple data points. The participant data can be split into two different categories: data with participant engagement and data without participant engagement. The number of total data points (both with and without engagement) will vary from recordkeeper and Managed Account provider, so please check with your advisor when evaluating. Here are some of the more common data items:
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- Recordkeeper provided: Age, retirement account balance, contribution rate (including match), life expectancy, location, and salary.
- Participant provided: Outside assets, risk tolerance, Social Security, gender, dependents, marital status.
The second main difference, and related to personalization, is dynamic asset allocation. Yes, target dates do dynamically update your allocation but only every five years (i.e., 2035, 2040, 2045, etc.). Managed accounts update allocations based on the changing of each data point. Therefore, allocations tend to be more dynamic than TDF allocations. At a minimum, the allocation will change once a year on the participant’s birthday.
The Positives:
So how can managed accounts improve plan outcomes? We believe that there are multiple ways including the following:
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- Participant peace of mind: professionals manage the account remotely through periods of high volatility and other market changes. This disciplined approach helps to improve better outcomes.
- The introduction of multiple data points improves the investment allocation process by personalizing it to the individual participant.
- Dynamic allocation changes come from both the recordkeeper and via participant engagement. This helps the participant stay aligned towards their retirement goal and creates more engagement with the plan.
- Managed accounts allow an advisor to extend their advice to the participant (i.e. value of the advisor’s fund selection process and the utilization of those funds in the managed account).
Simply put, managed account programs help participants keep on track for retirement and drive participant engagement. This is the next generation of improved individual advice in the 401(k) space.
The Negatives:
What about the downside? The #1 issue is cost. The good news is that there is no cost to the plan sponsor. Managed accounts are brought into the 401(k) plan as a choice to the individual participants and are usually charged as a percentage of individual assets in the plan. For instance, a participant with $100,000 in assets may incur a 0.50% or a $500 annual fee (fees are taken out quarterly from the participants assets). We have seen a wide dispersion of fees that range from 0.20% to 0.85%. The upper end of the range are often managed account programs provided by the large national recordkeeping providers. They pay advisors to push their Managed Account programs, thus the need for higher fees. On the lower end of the cost spectrum are the smaller independent recordkeeping providers who often negotiate costs with an independent managed account provider.
The managed account uses the same funds available to the participants on the fund menu. Depending on the advisor or investment provider, the funds could be comprised of actively managed funds, passively managed funds, or a blend of the two. Whatever the method, the associated expense ratios of the funds in the menu should be considered when looking at the total cost of the addition of accessing the managed account program. Fortunately, due to technical improvements and increased competition, costs have been going down over the past few years. This trend should continue as new and innovative providers jump on the growing need for managed accounts.
The second concern is the lack of an appropriate performance return benchmark. Since each Managed Account provider has 1) a different allocation strategy, 2) each plan uses different mutual funds, 3) each participant has their own personalized allocation, and 4) each participant has a different start date, this will prove to be illusive. However, the same can be said for Risk Models.
Finally, there needs to be interaction from the participant using a managed account program. Recordkeepers automatically provide basic data points needed for personalization. However, the individual participants must be engaged and provide personalized data. If not, they are not taking full advantage of the managed account service. Studies show that Participants who fully engage with the managed account program, either by themselves or through their advisor, have better retirement outcomes than participants who don’t.
Summary
Yes, managed account programs do have a place in the small 401(k) plan market. There is no reason that the same benefits and successes of managed accounts in large plans could not be applied to the small plan market. There are some shortcomings, but those can be overcome by searching for the advisor and/or recordkeeper to provide the right solution, deliver education, and increase engagement.
Important Questions
Do managed accounts improve outcomes? Below are some success stories from industry providers:
The Standard says that their managed account program has:
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- increased participations rate 30% compared to plans without managed accounts*
- 15-20% higher contribution rates than industry averages*
Lazard Asset Management:
By using managed accounts, 7-10 participants increased their projected 10-year retirement wealth by an average of 23% net of investment and advice fees.
Vanguard:
Managed account participants were most likely to initiate a change in deferral percentages and were also the most likely to increase their savings rate on their own.
Morningstar:
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- Of the participants who were categorized as “off track”, 71 percent increased their savings rate, and they did so by nearly 33 percent (or 2 percent of salary).
- the percentage of participants maximizing the employer match increased by 12 percent.
- the average wealth at retirement increased by 47 percent for previously off-track participants.
- the average 30-year-old could have almost 56 percent more annual retirement income, assuming a 0.40 percent annual fee.
NextCapital:
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- The estimated value add of Managed Advice is 0.95 percent (95 bps) per year, excluding the value of contributions and retirement age recommendations.
What questions should fiduciaries be asking?
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- Is it in the participant’s best interests? In contrast to that question…. Are the costs worth the potential better risk adjusted returns and a more appropriate allocation that changes automatically over time?
- How should Managed Accounts be used in the plan?
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- Should it be a participant opt-in or QDIA?
- Are your participants around the same age, but have different wages? Do they need more help with investments than the average participant? If so, a Managed Account might be a better option as a default than a TDF.
- Is the MA provider also the 3(38) Investment fiduciary for their allocation process? That depends on the provider. If so, this will help limit fiduciary liability for the plan sponsor.
So why should you investigate managed account programs for your participants?
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- Participants appreciate positive actions in support of their retirement outcomes.
- It is a more holistic solution that includes personal data (especially outside assets) and automatically updates the allocation with changes to the data points.
- Increases participant engagement which often results in higher deferral rates and better outcomes.
Who tends to use the service?
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- Participants that want guidance but do not have enough assets under management to qualify for full service advisory services
- Older participants that have more complexed needs as they get closer to retirement
- Younger participants that expect personalization from financial services firms
- Participants that are not comfortable managing or allocating their contributions among the different funds in the investment menu
- The median age of a managed account user is 49 with an average account balance of just over $200,000
How many plans have managed accounts?
In 2020,
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- 87% of all recordkeepers have managed accounts on their platform
- 39% of plans with 50-199 participants have managed accounts
- 50% of all plans have access to managed accounts
- 55% of workers would prefer their employer to use all available information to personalize their 401k program
How much is invested in Managed Accounts?
In 2022, Cerrulli Associates says that retirement plans have slightly less than $500 billion in managed accounts.
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