The Pension Protection Act (PPA) has ushered in a retirement debate that will rival the technology industry’s Betamax-VHS format war of the 70s and 80s. The qualified default investment alternative (QDIA) provisions of the PPA are changing the landscape of our industry, giving plan sponsors unprecedented fiduciary protection and providing more options for participants.
While our industry is quick to agree on the positive effect the QDIA provisions will have on both plan sponsors and participants, the question of which of the 3 QDIAs will be most widely used–managed accounts, target date funds, or balanced funds–is still open for debate.
By most indications, employers are proceeding cautiously into investment options they already know. According to a recent survey by Callan Associates, 79% of plan sponsors overwhelmingly prefer using a QDIA for their plan and target date funds are the QDIA of choice. The advent of managed accounts as a QDIA, however, has given plan sponsors more to think about. And while managed accounts have started off slowly, the option is now picking up considerable momentum, particularly with small businesses.
Managed accounts offer big options to small business
There are good reasons why managed accounts are beginning to catch on. Offering a benefit generally assumed to be available only to high-net-worth individuals or employees of larger companies represents an important edge for small business owners in the competition to attract and retain top talent. In fact, according to the 2006 Retirement Confidence Survey conducted by the Employee Benefits Research Institute, 70% of employees said they would be interested in using a managed account for their 401(k) plan assets.
Typically reserved for only the largest corporate plans with assets of $400 million or more, the managed account option was far out of reach for small business owners. Under the new QDIA provisions, providers are working to leverage scale and provide managed account services at a lesser cost for small business plan sponsors.
Now, small businesses with retirement plan assets of as little as $50,000 can contract with an advisor to offer a managed account QDIA to their employees. In fact, small businesses and startups new to the 401(k) market with zero qualified retirement plan assets can exercise this new option.
Small businesses can reap goodwill from their employees with a managed account QDIA. The managed account option lets employees get professional investment advice in a cost-efficient way while limiting plan sponsors’ fiduciary liability. For small business plan sponsors faced with participants who lack the knowledge or time to make the appropriate investment decisions, this option is a welcome alternative to default options under qualified retirement plans that leaned on money market funds which, over time, have yielded gains that fall short of the compounded interest most workers need to grow their retirement savings at an adequate pace.
Time is right for managed accounts
Professionally managed accounts combine the best features of their QDIA peers. Similar to target funds, managed accounts are adjusted according to an employee’s age. In fact, managed plans often provide employees with choices to fit their risk tolerance and allow participants to tailor holdings for special circumstances on an individual basis.
Most notable and a point likely to stick with plan sponsors and participants is that managed accounts, unlike their balanced fund QDIA counterpart, have the flexibility to react to market fluctuations–a key feature in today’s volatile economic climate. In times of economic uncertainty, having a seasoned independent investment manager there to make portfolio changes and move money to hedge risk is a valuable benefit. When circumstances are better, adjustments can be made to ensure participants the best long-term performance.
For small businesses with less cash in their plans, market fluctuations can have a devastating effect on participants’ retirement holdings, delaying target retirement dates or significantly impacting employees’ available discretionary income for retirement. Individual managed accounts can devise a balanced asset mix to fit an age group’s time horizon and market conditions. Knowing that the advisor of the managed account is making appropriate market decisions on behalf of participants can give plan sponsors peace of mind. Plan participants, in turn, are reaping the benefits of having a professional manage their personal retirement accounts and insure that financial decisions the professional makes on their behalf can stand the test of time and changing economic conditions.
While there is a fee associated with managed accounts, the most forward-thinking providers are working to mitigate costs for small business plan participants interested in implementing a managed account QDIA under these new provisions. Custom plan designs with a select fund lineup can alleviate the cost burden that may have deterred small businesses from adopting this strategy in a pre-PPA era of retirement planning.
While the market for managed accounts is small, it is growing rapidly under the new rules. A recent study by Deloitte Consulting found that 18% of the 830 companies polled offered their employees managed accounts, while another 17% were considering including the option in their plan selection.
Put simply, managed accounts fit the spirit of the Pension Protection Act, balancing the responsibility for investment decisions between plan sponsor and plan participant. Employees need not take all of the risk alone and employers are moved out of the uncomfortable position of providing investment advice.
Instead, participants can now turn to a professional for independent and objective financial advice. For small business plan sponsors especially, managed accounts offer a big plan feel that will help put them in a position to attract and retain top talent.
Dennis Mosticchio is senior vice president of group pensions for Guardian Life Insurance Company of America, New York, N.Y. Tim McCabe is vice president of sales and marketing for PMFM, Inc. a registered investment advisory firm. You can e-mail them at firstname.lastname@example.org and email@example.com, respectively.