Investing August 2, 2021

Considering New Uses for SDBAs

Self-directed brokerage accounts could be the answer for meeting participants’ ESG investing desires and maybe guaranteed lifetime income needs.
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Art by Allie Sullberg

Retirement plan participants are demanding environmental, social and governance (ESG) investment opportunities, and, recently, the Federal Thrift Savings Plan (TSP) announced it will make ESG funds available in a new mutual fund brokerage window for the plan.

In addition, some investment consultants say private equity can improve participants’ outcomes, and there is a clear need for guaranteed retirement income options for participants. However, no clear regulatory guidance on how to include ESG factors in investment selection for retirement plans has been given; the Department of Labor (DOL) has sanctioned the use of private equity only in asset allocation funds, such as target-date funds (TDFs), for defined contribution (DC) plans. And despite provisions of the Setting Every Community Up for Retirement Enhancement (SECURE) Act to encourage the adoption of in-plan retirement income products, plan sponsors are still hesitant to add them to their fund lineup.

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Could self-directed brokerage accounts (SDBAs) or managed accounts be the answer for meeting participants’ specific investment wants and needs?

Robyn Credico, managing director, retirement at Willis Towers Watson, notes that managed accounts typically use the core funds in the DC plan and determine risk and asset allocation based on these funds. If ESG-investment-type options are not part of the plan fund lineup, then it is unlikely that the managed account provider will use them.

Martin Schmidt, a retirement plan adviser at the Institutional Retirement Income Council (IRIC), concurs that most managed account providers use funds already on the plan’s investment menu; however, he says, some managed account providers are creating a sleeve of funds for which participants can receive advice. Yet, even if managed accounts offer the opportunity to use these types of investments, will the selection methodology of the provider pick them? Schmidt queries. “Some select the cheapest funds for the participant’s goal,” he explains. “If private equity and lifetime income are more expensive than other options, they may be bypassed.” Additional fees could be charged for advising on funds not on the plan’s investment lineup.

SDBAs can offer ESG investments via particular stock or funds, says Credico, and investment advice offered through managed accounts may cover options in the SDBA. However, the plan sponsor typically may not pick and choose which funds and stocks the SDBA makes available; in situations where sponsors do so, as plan fiduciaries, they will have to monitor all of those funds and stocks.

SDBAs Might Be a Better Solution

SDBAs would definitely be a vehicle in which plan sponsors could offer those types of investments, Schmidt says. Currently about half of sponsors make SDBAs available, he says, adding that very few participants use them. Exceptions are high-wage earners in professional service firm plans or airline pilots in plans for pilots. Still, Schmidt says, historically the message has been, “Go to an SDBA to get the investment you want.”

“I’m having more conversations with clients where ESG is front and center,” Schmidt says. “That’s becoming, or will start to become, the norm.” He doesn’t see plan sponsors clamoring to offer private equity in their investment lineups, though. “SDBAs can offer them, but the problem will be getting participants to use it,” he says.

As for retirement income products, Schmidt says SDBAs could reduce some of the fiduciary risk for plan sponsors, depending on how their plan is structured.

Gregory Kasten, founder and CEO of Unified Trust Co., says SDBAs could include different types of ESG investments, and participants would be able to select from a wide array.

Kasten warns, however, that Unified Trust’s extensive studies of SDBAs have found it is generally true that a participant in an SDBA—about 70% of the time—will underperform the rest of participants in that particular retirement plan. He says a variety of factors contribute to this, but most studies have found that the largest single holding in SDBAs is cash. “SDBAs do not take advantage of other income preservation options such as stable value funds,” Kasten says. “SDBAs link to money market funds or cash accounts to facilitate transactions, and right now cash is getting a 0% rate of return. I’ve seen people move money to an SDBA and put it in cash for over a year, foregoing earnings.” For this reason, he says, he’s always viewed SDBAs with skepticism.

Private equity investments can produce good returns, and SDBAs could offer private equity, Kasten says. However, participants’ understanding of private equity could be a problem. This vehicle has primarily been used by defined benefit (DB) plans to seek higher returns, he says, but studies are mixed as to whether private equity net of fees really generates that much in returns.

“Even a sophisticated investor could be making some large bets, which sometimes work out and sometimes don’t,” Kasten says. “In my own experience, returns can be higher, but so can costs, and the investments are too complex for the typical DC plan participant to understand how they work. I would find it hard to believe that even a plan participant who would consider himself somewhat sophisticated would understand private equity.”

SDBAs could also offer retirement income products, Kasten says. But the problem with buying fixed annuities is that, right now, they probably yield less than a stable value fund, he says. “Also, the participant would have to annuitize [the investment] and irrevocably convert it to lifetime income, and studies show few participants are willing to do this. They don’t want to give up control.”

According to Kasten, the one plausible thing that could work to provide retirement income for participants is to buy a no-load or low-fee variable annuity with a guaranteed minimum withdrawal benefit (GMWB) within the SDBA. As with private equity investments, though, it’s uncertain whether participants will understand how the investment works.

Offering participants access to an adviser along with the SDBA could help them understand and choose appropriate options, he says.

Additionally, participants don’t have to put all of their money into an SDBA, , Schmidt points out, and in many cases, sponsors put a limit on the amount of saving participants can allocate to it.

Plan Sponsors’ Fiduciary Duties

“One of the beauties of SDBAs from a plan sponsor perspective, is there is no increasing fiduciary responsibility from offering them,” Schmidt says. “However, if a plan sponsor selects and limits the offerings within the brokerage window, then it will have the fiduciary burden of selection and monitoring of funds.” He says plan sponsors need to do due diligence to determine if an SDBA is an appropriate investment vehicle for their plan.

In deciding whether to provide an SDBA option, “the sponsor needs to determine whether the participant population has the type of knowledge to understand how to use [it] and the investments within it,” Kasten says. “If an SDBA is offered, sponsors want to monitor whether participants are properly diversified.”

Plan sponsors also must do their fiduciary due diligence when selecting an SDBA provider. The sponsor must evaluate what services the SDBA custodian supplies and whether fees are reasonable, Kasten says. “The sponsor would also want the SDBA to be ERISA [Employee Retirement Income Security Act] Section 404(c)-protected and want to go through  the things it needs to do to ensure that,” he adds.

“Out of the three investment types, ESG will be easiest to offer through an SDBA,” Schmidt concludes. “It’s an easy way to solve for participant demand, and, with the increase in interest, I think SDBAs will have more assets flow into these types of investments.”

Administration July 30, 2021

Addressing Forgotten Accounts Can Improve Retirement Savings Outcomes

A better investment mix and increased savings are just two advantages participants who have disengaged with prior plan accounts gain by consolidating them, and plan sponsors can also benefit from helping them do so.
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“Lost” or forgotten defined contribution (DC) retirement plan accounts can have a major negative effect on retirement savings outcomes for individuals.

Research from Capitalize, a fintech company that consolidates 401(k) accounts into a new or existing employer-sponsored plan or individual retirement account (IRA), finds there are 24.3 million forgotten 401(k) accounts in the U.S. with approximately $1.35 trillion of assets in them, representing 20% of the $6.7 trillion total assets in 401(k) plans. For its research, Capitalize used the Department of Labor (DOL) Form 5500 database, which includes data from 2018. From there, it estimated the number of additional forgotten 401(k) accounts since then.

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Combining data from the DOL’s Form 5500 database, Vanguard and the U.S. Census Bureau’s Survey of Income and Program Participation (SIPP), Capitalize estimates that the average balance in forgotten 401(k) accounts in 2018 was $55,000.

One might understand forgetting about a $2,500 balance that was automatically forced out of a DC plan into a safe-harbor IRA, but it seems harder to forget about $55,000. However, Gaurav Sharma, co-founder and chief executive officer (CEO) at Capitalize, explains that the eye-popping figures are due to a broad definition of “forgotten” accounts to include accounts that participants have disengaged from.

“We were surprised as well to find that the average balance in forgotten accounts is higher than we would assume,” Sharma says. He explains that the term “forgotten” when it comes to retirement plan accounts doesn’t just include those accounts people don’t remember they have. “People leave money behind in old plans or IRAs, and even if they know it’s there, they don’t engage with it and have lost track of fees and investment options. If they are asked what they know about a prior 401(k), they don’t know much about it,” Sharma says.

Capitalize estimates that savers could be missing out on a combined $116 billion in additional retirement savings each year.

Sharma attributes the growing problem to the complex process of consolidating or rolling over DC plan accounts or IRAs. For example, a 2019 survey by Financial Engines found half of participants were unaware they could move money from their IRA to a 401(k). Rollovers rules vary between plan types, and education could be helpful for both plan sponsors and participants.

Benefits of Retirement Account Consolidation

Plan sponsors are allowed to force out balances below $5,000; those between $1,000 and $5,000 must be rolled into a safe-harbor IRA.

Using the same math for a $2,500 balance left in an old DC plan or moved to a high-fee safe harbor IRA, Sharma calculates that total foregone savings could total more than $31,000 over 30 years. This projection assumes the forgotten account incurs an annual fee of 0.85% and returns 1.00% annually, and that no more contributions were made to the account over the years. Sharma says the alternative option—a well-optimized retirement account—charges an annual fee of 0.40% and returns 9.2% annually. 

There are benefits to consolidating retirement savings accounts, says Sharma. He notes that it is hard to manage retirement savings among many different accounts, keeping up with fees and investments.

Sharma says money moved to a safe harbor IRA is often defaulted into low-risk investments such as money market funds because of the fiduciary duties involved. A 2019 Issue Brief from the Employee Benefit Research Institute (EBRI) found this to be true. Savings moved to a safe harbor IRA would generate a lower outcome for participants compared to savings rolled over to another employer’s retirement account that would generate higher returns with lower fees, Sharma adds.

By ignoring prior accounts, over time, the investment strategy might not match what a participant needs, Neal Ringquist, executive vice president and chief of sales at Retirement Clearinghouse, notes. For example, the savings in a prior plan might be invested aggressively because the participant was younger then, but now they should be invested more conservatively.

Spencer Williams, president and CEO of Retirement Clearinghouse, contends that the biggest risk of not paying attention to prior plan accounts is investment risk. “Investments are dynamic, and rebalancing is a staple of maintaining a saver’s investment profile,” he explains. “Without rebalancing, people could get greater exposure to the wrong investments at the wrong time and have an investment allocation that goes against their investment philosophy.” Williams adds that this problem is greater when a person gets closer to retirement age.

“In any one plan, participants can get proper investment diversification, so they don’t need multiple accounts,” Ringquist adds. “In retirement accounts with the same tax status, participants are not getting tax diversification, so there’s no real diversification benefit of multiple accounts. However, the benefits of consolidation are the ease of management and the elimination of redundant fees which will improve returns.”

Having multiple retirement accounts also complicates withdrawal decisions at retirement, Williams says. “We see that a lot; participants who get to retirement age trying to pull all their assets together. Doing so regularly as they move through their career is a better approach,” he says.

Spencer Williams, president and CEO of Retirement Clearinghouse, notes that consolidating retirement accounts also reduces exposure to cybersecurity risk. “The more financial accounts a person has, the more likely fraud will happen,” he says. Williams notes that Retirement Clearinghouse will be performing the roll in service for the Federal Thrift Savings Plan (TSP) next May as part of the TSP’s upgrade.

How Plan Sponsors Can Mitigate the Forgotten Accounts Problem

One way plan sponsors can help is to provide user friendly tools and education about what to do with DC plan account balances, Sharma says. “It will require a mindset shift of helping people make the most of their money, not just when they join a plan but when they leave,” he says.

Sharma points out that generally much less attention is given to employees who leave than when employers are onboarding a new hire. “When people leave [an employer], they are given disclosures and legalese—very dense paperwork—it might go into a drawer or the trash and not be looked at,” he says. “We provide an offboarding service for free to plan sponsors and terminating participants. Terminating employees are presented with the Capitalize platform as a way to seamlessly roll over their retirement accounts, but some people still might decide to leave their savings in the prior employer’s plan and some may need to cash out.”

Capitalize helps retirement savers locate old 401(k) accounts, compare IRA providers and roll the accounts over into an IRA of choice. Sharma says the rollover process is very paper-based and cumbersome and people don’t understand the process and are put off by the difficulty. “We put the process online and make it easy,” he says.

Ringquist says one way to look at it is that one plan’s terminated participant is another plan’s new hire, so plan sponsors can help participants who leave their plans as well as those entering their plans.

Ringquist says that first, it’s imperative that plan sponsors attempt to maintain current addresses with which to communicate to participants who leave. “They need to make sure the lines of communication are open,” he says.

Secondly, Ringquist suggests that plan sponsors have a program—at a minimum an educational program, but ideally a service—that communicates the benefits of account consolidation in an unbiased way. Plan sponsors could do that purely through education, but many plans have an adviser in place to help participants with decisions and some use a transaction engine that will help facilitate a rollover once a decision is made.

One solution to end having missing participants and forgotten accounts at the small time is for a plan sponsor to adopt auto portability, Ringquist says. An advisory opinion and prohibited transaction exemption from the Department of Labor (DOL) cleared the way for automatic portability programs in which retirement savings accounts can be automatically rolled from one plan to another for participants who terminate employment. The DOL’s actions were specific to Retirement Clearinghouse’s system.

With new hires, plan sponsors should encourage consolidation into their plans, if rollovers are allowed, Ringquist says. He notes that Plan Sponsor Council of America (PSCA) data shows around 96% of plans allow rollovers from other plans, but only two-thirds allow rollovers from IRAs. He suggests that plan sponsors consider making rollovers from IRAs permissible for participants, especially with more state-based auto-IRA programs being established.

Ringquist says the messaging for new hires should be about the benefits of consolidating retirement savings into one plan. In addition, plan sponsors should make sure new hires are familiar with the plan recordkeeper’s or a third-party’s system to facilitate rollovers.

Sharma notes that helping employees with accounts when they terminate is also in the best interest of plan sponsors. It can reduce per-participant or asset-based fees charged by service providers, as well as compliance obligations under the Employee Retirement Income Security Act (ERISA) that extend to terminated participants.

For plan sponsors, addressing forgotten accounts is also important because the DOL is “clearly on a path of expecting a due diligence process-driven approach to finding missing participants,” Williams says. “The expectation has moved to a point of having a regular program or process in place, kind of like the discipline structure of reviewing investments.”

“The most important thing, though,” Sharma says, “is to make sure participants don’t squander savings they’ve worked hard to accumulate.”

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