Managed accounts make for a better qualified default investment alternative (QDIA) than the other two options that the Department of Labor (DOL) permits—target-date funds (TDFs) and balanced funds—according to a new report from Towers Watson.

Managed accounts are customized for each participant and are built around their asset profiles and individual circumstances, according to “Are Managed Accounts a Better QDIA? Yes, But at What Cost?” Most employers use TDFs “because they are simple, cost-effective and dynamic over time, de-risking as retirement approaches,” Towers Watson says. Balanced funds, on the other hand, are generally rebalanced but not reallocated, and so they may not include enough exposure to equities for younger investors or too much exposure for older investors, the firm suggests. 

Unlike the two other options, managed accounts ask “participants to provide personal information and receive individualized asset allocations that are managed on an ongoing basis,” Towers Watson says. Furthermore, many providers ask participants about their retirement and income goals, outside assets and Social Security. They also suggest the percentage of salary employees need to contribute to achieve a secure retirement.

The accounts can comprise both the plan’s core investment lineup and outside assets, to create efficient, diversified portfolios for individuals. Outside assets such as real estate, long-duration bonds, annuities and alternatives “might be too esoteric to add to a defined contribution (DC) structure as a standalone for fear of participant confusion or misuse,” but as part of a managed account, they have attractive properties from a portfolio construction perspective, Towers Watson says. A handful of providers are also adding in guided withdrawal tools for retirement spending, though these are early in their evolution.

Just over half (55%) of respondents to Towers Watson’s 2014 DC Plan Sponsor Survey offer managed accounts, but a scant 3% use them as the QDIA. Across participants, actual usage remains low, according to Vanguard’s “How America Saves” surveys, with usage remaining at 6% to 7% between 2009 and 2013. Towers Watson believes the two reasons usage remains so low is that these funds are not being supported with enough communication, and that their fees are generally higher than TDFs and balanced funds. Large plans’ fees for managed accounts start at 50 basis points, but they are often much higher for smaller plans.

When plan sponsors consider whether implementing managed accounts as a QDIA is reasonable, fees are typically at the forefront, Towers Watson says. The U.S. Government Accountability Office (GAO) “specifically calls out fees as an important factor because higher fees can erode long-term savings. We agree with this statement and believe that the managed account industry needs to lower fees before we would expect meaningful adoption of managed accounts as the QDIA.” And, as managed accounts continue to adopt retirement spending tools, they will become more appealing, Towers Watson says.

Additional findings from the Towers Watson report are presented here.