While target-date funds solved many problems for both plan sponsors and plan participants, there is also increasingly widespread recognition that one size doesn’t quite fit all. As participants get older and closer to retirement, their financial lives often become more complicated, requiring more customized solutions than a target-date fund can provide.
In response, some plan sponsors are considering creating multiple qualified default investment alternatives, including managed accounts, in order to serve the needs of multiple cohorts of employees.
“We have been talking a lot to advisers about these ‘dynamic QDIAs,’” says Michael Doshier, senior retirement strategist at T. Rowe Price Intermediaries. Typically, the scenario discussed involves the automatic enrollment of young participants into a target-date fund, and then some trigger—such as age, account balance or some combination of similar factors or life events—causes participants to get automatically re-enrolled into a managed account solution.
“There’s a uniform belief now in the industry that the single, blunt-force instrument of automation is perfectly fine for a 25-year-old, but doing the same things for a 65-year-old could be dangerous,” he says.
Under the Pension Protection Act, plans have three options for QDIAs: target-date funds, managed accounts and balanced accounts. While target-date funds do have a glide path based on a participant’s age, managed accounts can take other factors into account, including assets outside of the plan, preferred retirement dates and their tolerance for risk.
While target-date funds remain the primary choice for most plan sponsors, managed account funds have evolved in recent years, with new technology bringing down the costs associated with them. But for now, when plan sponsors use managed accounts as their QDIA, most default all participants into them, rather than starting them in a dynamic QDIA, also known as a “hybrid QDIA.”
A Demand for Personalization
“Sponsors recognize that people want personalization and that the managed account programs have come a long way in terms of the data points and the personalization, and customization has increased,” says Nathan Voris, director, investment insights and consultant services at Schwab Retirement Plan Services in Richfield, Ohio. “So, you are seeing more adoption there. More advisers are also leveraging managed accounts as a tool in their toolkit or building a collective investment trust that they can use in a managed account.”
Empower Retirement was the first recordkeeper to introduce dynamic QDIAs in 2016, and other recordkeepers, including Fidelity, Charles Schwab and Principal have followed suit.
“Advisers are taking a much more active role, and that is driving adoption of these QDIAs,” Voris says. “We are seeing more and more plan sponsors and more and more advisers ask questions about our capabilities in this space and exploring it as an option.”
Voris says that multiple QDIAs are one of the top three discussion topics he engages on with advisers, and interest has increased significantly over the past three years. That said, adoption from plan sponsors remains low, he adds.
“That’s usually the last part to come,” he says.
An Opportunity for Engagement
Voris says dynamic QDIAs create an opportunity to engage with participants when they’re transitioning from a target-date fund to managed accounts. Such engagement can inspire an individual to start thinking about retirement, Voris says.
That, in turn, can lead to interest in having a financial plan, and provide an opportunity for the plan adviser to provide counseling and guidance. The ultimate outcome can be a participant who is more prepared to make the transition from accumulating assets for retirement to decumulating them in retirement, he adds.
For plan sponsors thinking about going that route, Voris says they should make sure that the methodology of their target-date funds is in sync with that of the managed accounts. If the target-date funds are passively managed, for example, the managed accounts should be as well.
In another twist on customizing QDIAs, Doshier says that he has also been speaking to some advisers who are starting to advocate for auto-enrolling some worker cohorts into a Roth 401(k), rather than a traditional 401(k).
“Many people who are at low incomes or tax brackets today will likely be at higher tax brackets tomorrow,” Doshier says, as incomes typically go up over time. So those individuals might be better off paying their taxes upfront now, while their tax rate is lower.
Risks to Consider
Some experts think having multiple QDIAs in a plan could prove too risky for plan sponsors.
“I believe that target-date funds will become more customized by plan sponsors over time, but right now there’s a lot of risk involved with that,” says John Hume, vice president at Segal Marco Advisors. “You’re seeing different lawsuits all around.”
Plan committees considering implementing such a structure should carefully document their decision process, Hume adds.
“In this litigious environment we are in right now, it’s all about the process,” Hume says. “You would have to follow a process that’s reasonable, with an investment consultant and a plan design consultant and a communications consultant. They would have to all come together and come up with a strategy that’s based on your plan population.”
That documentation should include not only the reasoning behind using a QDIA, but also the thought process behind the decumulation strategy, if the managed accounts include one, Voris says.
Given that managed accounts often require more engagement from participants than target-date funds (so that the manager can customize allocation), one solution might be to require participants to complete an education component before moving them from a target-date fund to a managed account option, Hume says.
Dynamic QDIAs are preferable to an approach that uses two completely separate QDIAs within the plan, because the latter route could cause confusion among participants, says Katie Hockenmaier, U.S. defined contribution research director at Mercer.
“It could also foster dissatisfaction if a participant receives targeted communications that one set of funds is intended for them, while they actually believe they belong to a different cohort with a different set of funds intended for use,” she says.
In addition, having multiple QDIAs could stimulate misuse.
“A sponsor can’t restrict participants from using certain funds while permitting other participants to defer into those funds,” Hockenmaier explains. “If two or more QDIAs are offered, it is possible that participants intended to use one QDIA may opt into another one that is not deemed as appropriate.”
Still, Hockenmaier says, with careful planning and communication, a dynamic QDIA could work, and she has seen a small number of plan sponsors implement them successfully. Another solution involves two different plans with different QDIAs. That option is popular among plan sponsors with a cohort of employees who have a legacy defined benefit plan along with their defined contribution assets.
“Sometimes, two DC plans are created where those with a DB benefit fall under one DC plan, as they will have a specific plan and investment design, given that they have known outside company assets that may impact their savings behaviors, and those without a DB benefit fall into a separate DC plan,” Hockenmaier says. “Given the plans are technically separate and participants have varied needs, two different QDIAs could be offered, one for each plan.”
In that case, the separation between the two plans makes it easier for participants to understand and use the two different QDIAs, she adds.
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