Plan Sponsors Have Questions About Dynamic Default Investments

Advisers and plan fiduciaries should keep abreast of new market offerings that may align with their participants’ needs. Such may be the case with new managed account strategies.

Nathan Voris, managing director, strategy, at Schwab retirement services in Richfield, Ohio, says managed accounts are growing in terms of market share. He says that 88% of the eligible defined contribution plans Schwab administers offer either managed accounts or advice as an option.

“I’ve noticed anecdotally that the consultant community is conducting more due diligence regarding using managed accounts as the QDIA,” Voris says. “If the consultants are starting to dig in to the details, then that’s a leading indicator that there will be some growth around the corner.”

Schwab recently built out the capability to offer dynamic qualified default investment alternatives (QDIAs), which are also called hybrid QDIAs.

The entry point for a typical hybrid QDIA is a target-date fund (TDF). But the thought behind a hybrid QDIA is that TDFs may lose their usefulness over time as individuals’ needs become more complex than simply maximizing accumulated assets. As the retirement date nears and wealth protection becomes more important, established investors may benefit from moving into a more individualized investment option that considers specific participant information about their risk tolerance, outside assets and other factors regarding their current and anticipated financial circumstances.

Employer adoption of hybrid QDIAs remains low at this early juncture. Voris says, “Although we have the capability to offer dynamic QDIAs to our sponsors, when managed accounts are included as a QDIA, they are still typically used as the QDIA for all participants in the plan rather than just a segment of participants.” 

Lorianne Pannozzo, senior vice president, workplace planning and advice, in Fidelity’s Boston office, says interest is picking up on hybrid QDIA’s. She says hybrid solutions by definition start as a simple and cost-effective balanced fund or TDF, then morphing into a professionally managed account when the account balance becomes large enough to make additional customization worthwhile. Like Voris, she sees some hesitancy persisting among plan sponsors when it comes to actually taking up this strategy.

“The number of questions we’ve been receiving from sponsors and consultants has increased, but we don’t have any who have gone down this route,” Pannozzo says. “I’d say that hybrid QDIAs are still in an evaluation stage and sponsors are taking baby steps towards it but not making what Fidelity calls its Smart QDIA the standard for their plan.”

In Fidelity’s Smart QDIA, plan sponsors enroll employees in either a TDF or a managed account; Pannozzo says the solution does not necessarily have to start as a TDF then evolve to a managed account.

“If a participant meets certain eligibility and criteria determined by the plan, then their initial default could be the managed account and each year after, they are re-evaluated to ensure they still fit the criteria assigned by the sponsor,” she explains. “Simply put, some participants will default to a TDF and eventually switch to managed account default over time as their situation changes and the criteria set forth is a fit, but it doesn’t have to happen in that order or sequence, it is unique to the participant situation and sponsor criteria.” 

Roughly one-quarter of Fidelity’s plan sponsors offer a managed account, and the number of individuals using Fidelity’s workplace managed account solution has grown 400% over the last five years. Nearly 50% of employers on its platform with 5,000 or more employees offer managed accounts.

When asked why plan sponsors are slow to adopt managed accounts as the QDIA, Pannozzo says they are still busy doing evaluations of the various options available. She adds that the first step is to make managed accounts available. Then, plan officials can run communication campaigns around an active opt-in.

But in general, Pannozzo says, progressive plan design features like this take a while to adopt. “For example, automatic enrollment had been around for a long time but it didn’t take off until the Pension Protection Act in 2006. Two percent of plans had auto-enroll in 2006 and now one-third of plans have auto-enrollment.” 

Pannozzo continues, “The same trends were there. Early on sponsors were concerned about enrolling employees in something they didn’t actively select. That same parallel exists today with managed accounts. They’ve done that with a QDIA around a target date and I think they are still in the testing phase for the managed account before they feel that comfort in making it the default solution for someone who may not have selected it.”