Managed Account QDIA Mechanics Challenge Plan Sponsor Clients

ERISA attorneys and plan design consultants say they are hearing more questions from sponsors about using managed accounts as a plan’s default investment, but the most common use case remains opt-in managed accounts.
Art by Wesley Allsbrook

Art by Wesley Allsbrook

Industry experts commonly say that managed accounts make sense for more engaged investors with a larger nest egg, or those with more unique needs that can benefit from a personalized asset-allocation approach.

In practice, it is older investors in retirement plans who tend to fit this description. However, plan sponsors are increasingly interested in the role managed accounts could play as a plan’s default investment—to be used by all new entrants into a plan who choose not to make an investment section of their own.

Want the latest retirement plan adviser news and insights? Sign up for PLANADVISER newsletters.

In her experience, many in the defined contribution (DC) plan industry are investigating managed accounts as the qualified default investment alternative (QDIA), says Jodi Epstein, partner with Ivins, Phillips & Barker in Washington D.C. However, opt-in managed accounts remain the most common use case, for a few key reasons.

“Having a managed account as the QDIA—as the default—means participants are not actively choosing it and providing more information about themselves,” Epstein says. “This is the information a managed account needs in order to tailor the underlying investment selections to individuals’ specific circumstances. In addition, I have a difficult time seeing how fiduciaries can justify the cost of a managed account compared to, for instance, a target-date fund.”

When it comes to “hybrid QDIAs,” which automatically roll participants from a TDF option to a managed account when certain wealth or age triggers are met, Epstein is also cautious. Actually deciding when and how to roll participants automatically from one product to another leaves Epstein with fiduciary concerns.

Epstein says, “If I had a committee interested in a hybrid QDIA, I would have them document how flipping a non-engaged 50-year old in a TDF at 15 basis points as opposed to a managed account at 45 basis points is prudent. The participant can opt out, but because this is the default option, they are by definition not engaged, so they probably won’t opt out, and the managed account is twice as expensive and may or may not give them much advantage.”

Managed accounts are the default for only 4% of DC plans, according to a 2018 Callan report, but the availability of managed accounts has steadily increased over the last decade, up from 6% of plans in 2005 to 55% of plans in 2017. Part of the growth in managed accounts’ popularity as a non-default option is driven by the ballooning amount of data available on participants. This has increased exponentially from 2007 compared to today, experts agree.

According to a Morningstar report called “The Impact of Managed Accounts on Participant Savings and Investment Decisions,” in 2007, most recordkeepers only knew a participant’s age and plan balance. Some recordkeepers also knew a few other data points which included salary, savings rate and the employer match amount. By 2017, though, most recordkeepers could cite many additional data points including salary, savings rate, brokerage accounts, location, loans, employer match and employer tiered match. Some recordkeepers also know a participant’s anticipated retirement age, pension access, gender and outside assets. As a natural extension of the increasing data availability, providers of managed accounts are working to automate their use of participant data, so that managed accounts can work well without needed the participant to plug in lots of information on their own.

“Within plans providing access today, managed account adoption as an opt-in varies greatly from low single digits to 40%,” says David Blanchett, head of retirement research for Morningstar Investment Management LLC. “The difference is based on plan sponsor support and how the managed account is integrated into promotion materials and on recordkeeper platforms.”

According to Mike Volo, senior partner, Cammack Retirement Group in Wellesley, Massachusetts, the price of managed accounts has been driven down substantially in the institutional marketplace. They are typically 30 basis points to 40 basis points on average, compared with a retail managed account that could range as high as 1% of assets. He says institutional managed accounts on a relative basis are quite appealing.

“Adoption is usually in the single digits because participants are often not aware that the managed accounts are available,” Volo “The big question is how and when to educate and encourage folks to engage with a managed account. It all comes down to targeted communications.”

Volo suggests the adviser working with the plan sponsor and the recordkeeper can outline a communication strategy to target the participants for whom a managed account may be a good solution. Whether the campaign is based upon age, account balance or likely a combination of both, participants can receive targeted communications making them aware of the offering.

Lorianne Pannozzo, senior vice president, workplace planning and advice, in Fidelity’s Boston office, agrees that targeted communications have the most impact. “Success is a matter of who you send the value proposition to and letting them actively opt-in to it.”

There is a very clear value proposition for a managed account—it’s personalized and suits those with more complex financial needs, Pannozzo says. “At Fidelity we have support tools to help a person decide whether or not they can invest their assets themselves or if they are a target-date fund or managed account type of investor. In most instances, you are sending targeted communications and allowing the participant to decide for themselves what is right for them.”

From a plan sponsor fiduciary perspective, Epstein says it is much less risky telling participants a managed account is available rather than defaulting them into one. She would suggest to clients that they use verbiage such as “you may want to consider” or “you may want to learn more about this option and here’s how to do that.”

“If it’s available as an option, you certainly want people to know it’s there. And it’s fine to explain who it may be appropriate for—what age or level of assets in plan and out of plan,” Epstein says.

Nathan Voris, managing director, strategy, at Schwab Retirement Services in Richfield, Ohio, says, “It’s easy to talk about the pre-retiree and managed accounts because it’s more tangible. But if you look at the math there’s a lot of value for younger folks as well.”

He says there are a lot of advantages for even the average Millennial to enroll in a managed account, assuming the account has reasonable fees. He suggests the personalization that comes along with a managed solution means even younger participants tend to be more at-ease during periods of volatility.  

Assessing Likely Impacts of IRS Hardship Withdrawal Rule Changes

New rules established by Congress and the IRS simplify the process for participants to request a hardship withdrawal of DC plan assets; some experts say this could increase “leakage,” while others anticipate more positive effects, such as lower debt among cash-strapped participants.

Art by Claudi Kessels


Back in 2018, the Republican-controlled Congress enacted statutory changes affecting 401(k) plans as part of the Bipartisan Budget Act of 2018, including changes to the rules for accessing hardship withdrawals.

The broad consensus at the time was that Congress was making it significantly easier for participants to access 401(k) dollars in the case of hardship, for example by allowing participants to simply self-certify that they are experiencing a financial hardship. Previously, the employer was required to obtain documentation from the employee, detailing and proving the hardship. Furthermore, under the old system, participants would have to suspend additional deferrals into the plan for six months after taking a hardship withdrawal; the new system bans this requirement.

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

In November 2018, the Internal Revenue Service published detailed guidance that effectively built out the practical framework it will be using to apply the new rules established by Congress. Experts have now had some time to absorb the IRS guidance, but they are still split on exactly what the broad retirement industry impact could be. 

Reviewing Changes to IRS Hardship Rules

At a high level, the IRS’s rules governing hardship withdrawals are organized around two broad considerations, says Amy Ouellette, director of retirement services at Betterment for Business in New York. The first area sets out why a retirement plan participant could apply for a hardship withdrawal, and the second discusses the standard for determining whether a given hardship request in fact involves an immediate and heavy financial need.

With the new changes, a seventh broad reason (disaster-related casualty losses) has been added to the IRS list of reasons why a retirement plan participant could apply for a hardship request, Ouellette says. The list now includes the following items:

  • Medical expenses that are not reimbursed
  • Purchasing a primary residence
  • Avoiding eviction or foreclosure
  • Repairing damages to one’s primary residence
  • School tuition fees and room and board for a family member or beneficiary
  • Funeral expenses
  • Disaster-related casualty losses

Another important change to consider is that, previously, participants could only withdraw contributions to their 401(k)—not earnings or matches, Ouellette says. Now, however, participants can be permitted to withdraw from those additional sources, she says.

Furthermore, there isn’t a stated IRS limit on how much a person can withdraw for a hardship, Ouellette says. For instance, if they are facing foreclosure or eviction, they could withdraw $200,000 or more. However, she adds, a plan sponsor’s own policies around loans may not permit such a sizable withdrawal.

Mike Windle, a retirement planning specialist at C. Curtis Financial in Plymouth, Michigan, has never witnessed a hardship withdrawal of that magnitude. “The most I ever saw a sponsor permit was a maximum of 25% of a person’s balance,” Windle says. “Typically, they are capped at 10% to 15% of one’s balance.”

Previously, a participant had to exhaust the loans available to them before taking out a hardship withdrawal. Congress and IRS have changed that to permit sponsors to sidestep the loans to allow participants to go straight to the hardship withdrawal. Several experts say that, because participants are required to repay the loans back to their accounts, loans are much more preferable than hardship withdrawals from the retirement security perspective. Hardship withdrawals cannot be repaid in the same way.

To be clear, as noted in a summary published by attorneys with Kramer Levin, the new system eliminates the old requirement that elective deferrals be suspended for a period of six months following a participant’s receipt of a hardship distribution. “Under the proposed amendment to the regulations, while sponsors may eliminate the six month suspension for plan years beginning on or after January 1, 2019, plan sponsors must eliminate the suspension required for plan years beginning on or after January 1, 2020,” the attorneys explain. Further, while the new system eliminates the requirement that a participant must take any available loans under the plan prior to taking a hardship distribution starting in 2020, it does not establish that plan sponsors cannot keep this requirement.

“Unlike a loan, you don’t pay the hardship withdrawal back,” says Tom Foster, national spokesperson for MassMutual’s workplace solutions unit in Enfield, Connecticut. “That money is just gone and there is no way to make that up unless you increase your deferrals to your 401(k), but most employees taking out a hardship withdrawal are unable to do that.” Additionally, Foster notes, the funds are subject to taxes, and if the participant is under the age of 59 1/2, they have to pay a 10% penalty.

Whether an individual is taking out a loan or a hardship withdrawal, those leakages set their final retirement nest egg back by 14% on average, he notes.

IRS Addresses Participant’s Immediate Needs

Dominic DeMatties, a partner with Alston & Bird in Washington, D.C., says he believes that Congress has made it possible for plan sponsors to permit participants to sidestep loans before taking out a hardship withdrawal due to the immediate needs that these participants face.

“Congress has recognized that for people under financial duress, it may not be practical for them to wait for the whole process of taking out a loan and then seek a hardship withdrawal,” DeMatties says. “So, instead of requiring someone go through two hurdles to get to a predetermined end game, they are making it possible for a person to just go through one hurdle, which takes less time.”

Snezana Zlatar, senior vice president and head of full service product and business management at Prudential Retirement in Woodbridge, New Jersey, agrees: “Congress has focused on individuals undergoing true hardship. In that context, we believe that the elimination of the loan requirement actually does make sense because if an individual is in a tough financial situation, loan repayments could very well be a financial burden to them. Additionally, loans may not be enough to meet their financial hardship.”

Mike Zovistoski, managing director at UHY Advisors in Albany, New York, has not witnessed many participants taking out hardship withdrawals. He believes one of the main reasons is that employees do not always want their employer to know about what they may feel is an embarrassing financial situation.

“Concerns about having your employer know your financial status has discouraged a lot of employees from taking hardship withdrawals,” he says. Furthermore, most of his plan sponsor clients “have the paternal instinct,” Zovistoski says. “They want to protect employees from themselves,” so he does not expect many of his clients to make plan design changes to permit their employees to take out a large hardship withdrawal without first going down the loan route.

So, Will Hardships Increase?

Stepping back and assessing this moving picture, Windle says that with so many people wanting to access their 401(k) funds before retirement, he is afraid that the new IRS provisions could lead to more leakage. “There aren’t a lot of people hip to [this new system] yet,” Windle says. “But once people start to realize this is available, they are going to start to use it. 401(k)s were created to incentivize saving for retirement. To use the funds ahead of time puts us back at square one.”

DeMatties agrees: “Without a doubt, the new rule makes it easier for people to access money in the event they have a hardship. Where the jury is still out is to what extent participants will utilize these procedures and access the money even when they do not truly qualify for one of the seven reasons the IRS has spelled out.”

Zlatar says one way retirement plan advisers and sponsors can discourage participants from taking out either an unneeded loan or a hardship withdrawal is by helping them set up an after-tax emergency savings feature. Prudential and other providers have already built such features into their recordkeeping platforms. “Our position is that a short-term emergency savings option within the 401(k) plan is the best alternative to a loan or hardship withdrawal, which is why we make this available,” Zlatar says.

Educating participants about the need to establish a budget and an emergency fund should also be part of that equation, Foster says. Sponsors should also offer alternatives to 401(k) leakage, such as health savings accounts (HSAs), long-term or critical illness insurance and information on low-cost loans, he says.

A participant might also rethink taking out a loan or hardship withdrawal if the sponsor requires them to sign a document outlining the downsides, Foster adds.

Other Considerations

One positive component of the new rules is that people with hardship withdrawals will no longer be precluded from contributing to their 401(k) for six months, notes Chad Parks, chief executive officer of Ubiquity Retirement + Savings in San Francisco. Because of inertia, that requirement has often led to participants never resuming deferrals to their 401(k), Parks says.

“That could help substantially with retirement readiness,” he says, “because you are no longer asking people to stop contributing to their 401(k). With participants continuing to contribute to their 401(k), I would hope that these people will still come out ahead.”

One other important aspect related to the new rules is that a sponsor no longer is required to keep evidence of the hardship expense and also may rely on the participant’s representation that he or she has no other financial means to alleviate the hardship, DeMatties says. “Instead, the sponsor can keep a summary of what is in the source documents that substantiate the hardship expense,” he says. However, the IRS might conduct a plan audit and ask for those source documents if certain requirements are not met, he warns. For that reason, Zovistoski believes it is a best practice for sponsors to still require copies of the source document.

«