Engaged in Investing?

As the work force ages, the stakes have risen for 401(k) participants managing their money, says adviser Randy Riggins, a principal at First Financial Resources in Charlotte, North Carolina. “People are starting to think more in terms of monthly income in retirement, versus their account balance,” he says. Without that frame of reference, he says, many have not understood the cost of achieving their retirement dreams or how to reach that savings goal.

That increasing realization has piqued interest in managed accounts, which can offer greater customization and hand-holding than options such as target-date funds (TDFs) or participants assembling their own portfolios—although they generally come with additional costs and require participant involvement. Thirty-eight percent of plans surveyed by consultant Aon Hewitt now offer managed accounts. Another 24% said they are very or somewhat likely to start offering them this year, according to Aon Hewitt’s 2012 Hot Topics in Retirement survey. Managed accounts “have actually grown consistently, year over year,” says Alison Borland, Aon Hewitt’s retirement outsourcing strategy leader. “Their use is up dramatically, compared [with] 10 years ago.”

If plan sponsors are interested in pursuing a managed account option, advisers can help sponsors think through the following five considerations.

1) Know why they appeal to some. Given their potential for more customization, managed accounts appeal to, in particular, older participants with more complex finances and who are close to retirement, Borland says. “Plan sponsors see that participants are not making great decisions on their own.” Some plans offer a managed account with a drawdown feature that creates a monthly payout in retirement. Compared with in-plan insurance options, “it feels less risky” for sponsors concerned about fiduciary complexities of the insurance-based options, she says.

Adviser Bruce Gsell says he sees how managed accounts, and the advice or guidance that comes with them, appeal to people near retirement as they cope with the end—at least for now—of watching steadily rising 401(k) accounts amid a robust U.S. economy and stock market. “If you look at the S&P over the past five years, it is negative,” says Gsell, an Edison, New Jersey-based managing director at Merrill Lynch. “At the same time, the cost of health care is going up 7% or 8% a year. Social Security is in trouble. Their spouse or their friends are out of work. And they have no idea if they have enough money for retirement. People want to talk to somebody, because they are really worried.”

Usually about 10% of participants choose a managed account when their plan offers it, Riggins says. “In my experience, it is the more educated consumer[s] who understand that they do not have all the expertise to make all the decisions on their own,” he says. “The average employee is more likely to say, ‘If it costs more, I am not going to do it.’” Target-date funds work for many of them.

2) Consider the default pros and cons. Managed accounts can be a qualified default investment alternative (QDIA), but only 5% of plans designate them as such, according to PLANSPONSOR’s 2011 DC Survey. Adviser Martha Tejera has seen sponsors’ opinions about using managed accounts as a default investment fall into two camps­—“those who think it is a better mousetrap than a target-date fund, and those who see a target-date fund as the most efficient way to accomplish the same thing,” says Tejera, project leader at Tejera & Associates LLC in Bainbridge Island, Washington. If defaulted participants do not take the initiative to supply information about their broader financial lives, the extra fee for managed accounts’ customization makes a lot less sense.

Tejera says she has seen no studies that finds managed accounts outperforming target-date funds, after fees, for participants who do not provide that personal information. “It is hard to go down that path,” she says of selecting a managed account default. Without such a study, “it is up to a managed account provider to present compelling data that shows managed accounts help participants recover the higher costs—and then some,” she says. “Without that, especially given the courts’ and the regulators’ focus on fees, it is hard to make a case for managed accounts as a QDIA.”

Gsell, in contrast, calls himself “a huge proponent” of pairing managed accounts and advice in lieu of target-date funds. Every defaulted participant who supplies personalized information is one more person with a customized managed account rather than a target-date fund, he says, adding that Merrill Lynch charges no separate fee for advice. Even if participants have the No. 1 target-date fund in performance, he says, many do not know if they have saved enough for retirement. “If you do not tell them how much they need and what they need to do to get there, I think these people are lost,” he says.

Concerning how he approaches discussing the default issue with sponsors, Gsell says, “The key thing is we talk to them about, ‘How are your participants positioned for retirement? Do they know what yearly income they will need?’ And if they are just considering 401(k) assets and not looking at outside assets, they are not taking a total financial snapshot.”

3) Understand the push needed for real customization. Some sponsors are under the impression that the only way managed accounts are better than target-date funds is if participants fill out a questionnaire and provide information about their outside assets, Tejera says. “Our history with our participants is, they are not going to take the time [to do that],” she says. If a plan uses managed accounts as a default, she continues, “the only thing you have to go on may be their age—and then you are back to target-date funds.”

How can providers engage participants so that managed accounts work as intended? “I do not think there is a magic pill out there [to make that happen],” Tejera says. “It is up to the participant. It is more likely if they are older.”

Gsell shares his perspective of the effort required to push participants to take that action: “We go in and do seminars; we demo advice; we go through every aspect of participant fees. We are very clear about how outside investments and retirement-income streams impact the analysis.”

He also asks participants to provide related financial information. “Many times, in the second and third round of meetings, we are helping them input that information,” he says. “We also do a lot of one-on-one meetings. We walk each person through [his] personal analysis and show [him] the key features of the advice.”

4) Evaluate factors beyond the investment itself. When plans offer managed accounts as an option alongside other investments, and not as the default, Tejera says, the higher fees are somewhat less of a concern. “The people who are going to choose it, by definition, are engaged,” she says.

Riggins agrees: “The employee is not stepping into the solution blindly, and it is ultimately [his] decision.”

When helping a sponsor who is considering adding managed accounts to a plan, Tejera suggests key elements to discuss, beyond the investment itself, including the communications wrapped around them, the ease of use for participants and the help people get with the transition into post-retirement. Managed account providers can argue that, unlike target-date fund providers, they help participants realize that they need to contribute more, she says. Participants need to find out the specific effort a provider makes to improve the adequacy of their retirement savings. Tejera hopes to see that effort go further. “I would like to see them provide some guaranteed solutions, particularly longevity insurance,” she says. “It needs to be more robust than a simple 4% drawdown strategy.”

5) Frame the broader participation discussion correctly. Managed accounts can play a role in a multifaceted solution to get participants on track with retirement savings, Riggins says. For example, Financial Resources holds group meetings to explain what options and tools employees have, as well as one-on-one meetings to discuss participants’ individual goals.

For managed accounts to work best, participants need the broader issue well-framed. “If you go to a participant and ask his or her vision for retirement, most people can articulate that clearly,” Riggins says. “But they cannot monetize that dream. They cannot say, ‘Oh, gosh, that is going to cost me $1.5 million.’ That is a big disconnect.

“The whole thing is—and what we are trying to get across—is that you have got to frame up somebody’s dream,” Riggins continues. “And you have got to tell them, ‘This is the behavior today that is going to take you to that place.’” Participants need to better understand their own risk tolerance and ultimate goals, he says. “Managed accounts are just going to be a component of the solution. This whole deal of getting coaching is gaining traction. More employees are coming to understand that they do not know enough.”