25 January 2022

The Re-Monetization of Retirement Plans with Managed Accounts

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The retirement recordkeeping landscape has evolved significantly in recent years. The number of competing providers has declined dramatically as numerous mergers and acquisitions have consolidated several firms, and those providers still operating have continued to reduce fees in order to remain competitive.

It’s also important to note the substantial increase and broadening scope of fiduciary breach litigation, in which excessive fee complaints are the most prominent claims. According to JP Morgan, more than 275 such lawsuits have been filed since 2006, with nearly 100 of those filed in 2020 alone. It seems reasonable to assume that each of these factors has played a role in the compression of provider fees.

While lower fees can generally be viewed as a positive development, recordkeepers may have less incentive to continue to invest in improved technology, better education, or other enhanced capabilities in an environment of wafer-thin profit margins.

As the old model adding to revenue through proprietary investment products has become less prevalent, many industry professionals fear that recordkeepers will be forced to monetize relationships in other ways. One area of growing popularity has been managed account services.

Managed account programs are platforms that provide participant investment advice, often formulated in a “robo-advisory” model through a computer algorithm that matches participant data to a proscribed investment allocation. Plan participants who opt into the service will incur an additional fee, generally paid directly from their account. These services are often promoted as a superior, professionally managed alternative to target-date funds.

While target-date funds consider only a common time horizon, managed accounts may factor in the participant’s age, financial circumstances, assets held outside of the retirement plan, and other unique information to customize the portfolio. Many managed account services also include retirement planning tools to assist participants in calculating contribution rates necessary to reach their unique retirement income goals.

The catch 

While all of this can sound like a great benefit to participants, there is something of a catch: the cost. Participants pay a substantial fee for this service, typically a percentage of the account’s value, in addition to the expense of the underlying funds selected as part of the portfolio.

Depending on the service provider and the value of the account, a managed account can cost 0.15% to 0.65% or more. As a result, some participants pay a low fee while others pay a comparatively large fee on their account balance for as long as they are opted into managed account services.

The potential long-term effect of managed accounts on performance and fees will vary, but the very nature of fund expenses is a diminished return. Managed account participants pay substantial added fees, reducing their balances over time unless the performance gain of the service outpaces the added cost.

Another issue to consider around managed accounts is their parallel to target-date funds. Target date funds, like managed accounts, were created to tailor account investments for the “do it for me” participant. Target date funds provide portfolios based solely on a participant’s anticipated retirement dates, shifting from stocks to more conservative bonds as participants get closer to their expected retirement year. Notably, managed account services will almost never recommend that the participant elect the target date fund offerings in the plan, even if that may be the most suitable option given his or her financial situation and age.

Fiduciary litigation 

Recent fiduciary breach litigation has targeted both the suitability and fees related to managed accounts. A participant in the Nestle 401(k) plan initiated a class-action lawsuit alleging that, in most instances, the asset allocation created by the managed account service was not materially different than that of the lower-cost target-date funds.

Furthermore, the complaint alleges that Nestle defendants allowed participants to pay an annual fee of 0.50% on the first $100,000, 0.40% on the next $150,000, and 0.25% on assets greater than $250,000 for managed account services. When combined with the expenses of the underlying investments used by the managed account, the costs far exceed the expenses of a target-date fund.

It’s worth noting that the recordkeeper, not the advice provider, generally receives a sizable proportion of these fees for distribution of the services to plan participants, thereby monetizing the relationship and perhaps creating a direct conflict of interest.

“It remains to be seen whether managed account providers follow this trend with their fee structures.”  

Plan fiduciaries must consider the necessity and reasonableness of fees when evaluating participant-paid investments and services. The Nestle lawsuit referenced above calls into question the necessity, given that materially similar asset allocations are provided to the participant through both vehicles. Likewise, the complaint questions the reasonableness of fees and asserts that “the reasonable fee is zero or very close to zero.”

In fairness to managed account providers, one must acknowledge the value of retirement planning services and the inclusion of assets held outside of the plan, which are not considerations of target-date funds. But fiduciaries must also determine if a variable, asset-based fee structure is appropriate for a managed account service.

Using the fee schedule described above, a participant with a $10,000 account balance would pay an annual fee of $50, while a participant with a $500,000 balance would pay $1,725. Given that the advice for both accounts is created from the same computer algorithm, is it reasonable for the participant with the large balance to pay over 30 times more for presumably the same service?

Another trend in the recordkeeping industry is moving from asset-based fee structures to a per-participant, flat-dollar arrangement. It remains to be seen whether managed account providers follow this trend with their fee structures.  

While managed accounts may provide a meaningful and valuable service to certain participants, depending on the unique circumstances, plan sponsor fiduciaries should carefully consider the necessity, suitability, and reasonableness of fees when evaluating these services on behalf of all of their participants. It’s also advisable to monitor the outcome of recently filed litigation related to managed accounts.

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