When an employer offers its workforce a 401(k) plan, employees typically can choose their investment options and planning. In other words, they can manage their own account; they can choose high or low-risk investing, or a little of both with relatively moderate risk.

Of course, they can also do nothing. Which means, under Department of Labor (DOL) regulations, they have “defaulted” and their money goes into what the DOL calls a “qualified default investment alternative,” or QDIA. There are three DOL-approved QDIAs: Target-Date Funds (employee chooses fund on expected retirement date), Balanced Fund (a single fund option) and managed funds (offer a combination of advice and professional management, based on several employee needs and considerations).

Low adoption right now

While managed accounts are one of the three options, a Towers Watson survey shows only 3% of plan sponsors use managed accounts as the default option - although they have gained traction as a supplemental advice tool that participants can access independently for guidance. On the other hand, a recent study by Morningstar found that participants increased their savings rates by nearly 28% after using managed accounts/advice.

In a recent white paper titled “Are Managed Accounts a Better QDIA? Yes, but at What Cost?” Towers Watson says that managed accounts are picking up some steam, especially since provider service offerings have improved. 

The main issue, says David O'Meara, senior investment consultant at Towers Watson, is that current fees for managed accounts remain a major roadblock to further adoption by plan sponsors. 

“We know the range of additional services that managed accounts offer should have added costs associated with them, but we also believe the industry needs to lower fees before meaningful adoption of managed accounts as a default option can happen,” O’Meara says.

The Towers Watson paper provides additional perspective on what could make managed accounts more attractive. For example, since younger participants have less complex financial situations and may not need all of the benefits of managed accounts early on, a sensible approach may be to rout young participants into an asset allocation based solely on age. Then, employers could transition them to a managed account as they develop more complex circumstances approaching retirement. 

According to O’Meara, managed accounts provide participants with a better understanding of their financial wellness. Combining these aspects helps participants effectively prepare for retirement and reduce retirement anxiety, which allows them to focus on their work.

“Managed account service offerings and associated fees are highly integrated with the plan record keeper,” O’Meara says. “So plan fiduciaries need to work both channels to drive an improved value proposition for their participants.”

Competition among managed account providers is rising, he adds, which will help boost adoption. O’Meara encourages plan sponsors to conduct due diligence on the various offerings as they become available to determine which solution might offer the best fit for their participants’ needs.

Engagment required

Martha Tejera, a retirement advisor at the Institutional Retirement Income Council (IRIC), says a key value proposition of managed accounts is the ability to customize the asset allocation to reflect the participant’s risk tolerance. 

“Of course, the participant must be engaged and willing to provide the additional information,” she explains. And since a QDIA is for participants who do not make an active decision, the defaulted participant is – by definition – not engaged. So that needs to change for a managed account to work effectively.

Tejera says some compelling statistics show that target date funds (TDFs) in general outperform participants who construct their own portfolios.  And while she believes managed accounts likely outperform what participants can achieve on their own, she has not seen any studies that convince her that managed accounts consistently outperform target date funds.

Even with those concerns, O’Meara notes, managed accounts have improved and can provide useful benefits for participants as they aim to holistically plan for their retirement.

The Towers Watson white paper concludes that employers/plan sponsors should work with the financial industry to create an “ideal” managed account offering for a 401(k) plan's QDIA.

“Especially with regard to fees, progress is needed,” O’Meara says. “But with the objective of successful retirement outcomes in mind, managed accounts can help the industry solve the retirement income puzzle for employees.”