Empower evolving 401(k) defaults with TDF-managed account hybrid

Empower Retirement, a unit of Great-West Financial, is developing a new type of default investment for 401(k) plans that fuses target-date funds and managed accounts to try improving on what some see as a shortcoming in how TDFs are structured.

The product harnesses the idea of automatic enrollment to automatically shift TDF investors into a managed account upon a “triggering” event such as age, employer tenure or account balance, according to David Musto, president of Great-West Investments.
The automatic shifting from TDF to managed account is a concept analysts and advisers say they haven’t seen elsewhere on the market, and would mark an evolution of sorts in the conversation around default investing in 401(k) plans.
However, some question whether managed accounts are truly the best option for everyone and whether the default route is a sound approach.
“To say that’s going to be the default and say you’ll change everyone to that, that’s a tough sell,” said Sean Deviney, an adviser who runs the retirement plan department at Provenance Wealth Advisors.
Empower, one of the largest record keepers of defined contribution plans, with $440 billion in assets under administration, plans to launch its product around mid-fall and to offer advisers and plan sponsors optionality around what triggering event they’d like to use.
Empower-administered plans would be the only ones able to access the product initially. Plans could use any TDF provider, but would need to use a Great-West managed account.
Of the $763 billion in target-date mutual fund assets, Great-West ranks 13th with $6.3 billion, according to Morningstar’s 2016 TDF report. By contrast, leader Vanguard Group has $225 billion.
TDFs have become plans’ default of choice since the Pension Protection Act of 2006 codified the notion of a qualified default investment alternative. QDIA rules give plan sponsors legal protections for defaulting participants into a TDF, managed account or target-risk fund.
Nearly 75% of 401(k) plans use a TDF as their QDIA, according to the Plan Sponsor Council of America. Only 8.5% do so with a managed account.
Research firm Cerulli Associates estimates TDFs will capture 90% of new contributions to 401(k) plans by 2020.
Some, such as Mr. Musto, argue TDFs may not be the best default for some investors because the funds lump similar-aged participants into one asset allocation, without regard for characteristics such as risk tolerance or savings objectives.
Managed accounts are able to tailor asset allocation to individuals, and are therefore better suited than TDFs for some, especially for near-retirees, who may have more complex situations, Mr. Musto said.
“I agree there are limitations to the TDF. It’s a one-size-fits-all for all the plan participants, and that’s not perfect by any stretch of the imagination,” Mr. Deviney said. However, he and others question if the additional cost for a managed account, which tacks on an additional management fee onto that of underlying investment funds, is worth it.
Some providers charge 50 basis points or more of assets managed by the service, on top of the underlying fund fees, according to a 2015 Morningstar report on default investing in DC plans. That report argues managed accounts “have a number of important advantages over TDFs” in terms of “producing better investment outcomes for investors,” but says cost has deterred uptake.
Mr. Deviney said he would want to understand what the Empower product offered for the additional cost, because many times he’s found the value lacking for the price in managed accounts.
Mr. Musto declined to say what the pricing for the Empower product will be, but said that, beyond a tailored asset allocation, the Great-West managed account offers additional benefits such as guidance on Social Security claiming and tax considerations when drawing down certain retirement accounts.
Jeff Holt, multi-asset analyst at Morningstar, said the logic behind Empower’s product is understandable — that individual financial situations are different for investors near retirement than when they’re young.
However, beyond cost, investor involvement poses a problem for managed accounts, Mr. Holt said. Investors typically need to proactively enter in information — assets in outside accounts and risk tolerance, for example — in order to optimize a tailored asset allocation, but default investments are traditionally for the uninvolved investor, he said.
Mr. Musto said the Empower product will be able to aggregate most account information, and participants will be part of a transition “program” when they shift to a managed account in order to promote engagement with the service. He declined additional information on what the program entails.