Steve Anderson heads Schwab Retirement Plan Services, which provides retirement plans covering 1.5 million employees. He assumed the role in 2008, and has been with Schwab since 1999. He recently spoke with EBN on a wide range of retirement plan issues, including the growing interest in managed accounts as qualified default investment alternatives.

What are the biggest concerns you’re hearing from plan sponsors today?

Most employers are very interested in having an engaged workforce. Part of that is having employees tuned in to their benefits, including retirement plans. They want to know whether their participants are taking full advantage of them – are they saving enough, are their investments appropriately diversified. Those have been historical questions, but they’re still out there today.

There is a lot of talk these days of financial wellness. Where does that fit into the picture?

Yes, that’s also something employers want for their employees, like doing a better job managing their debt, their credit cards, and their household finances. That helps them stay focused on the job, when they’re not worrying about money as much.

Also see: In-person coaching important component of financial wellness programs

We’re also hearing more and more from our plan sponsors that they’re interested in a broader array of communications and programs to support overall financial wellness. I think a lot of that is stemming from the success some have seen with their more medical [type] wellness programs, and they view this as being something that could be the next wave in terms of employee education in the workplace.

Does employers’ worry about employees’ debt management translate into not allowing 401(k) plan loans?

Some of our plan sponsors have elected not to have loans in the future. It is, though, probably the minority of plan sponsors. Most do allow loans. Unfortunately, some allow multiple loans, so it somewhat compounds the issue. When a plan has a loan feature, it’s really difficult to take it away.

What are the key messages the participants need to hear to make the most of their plans?

No. 1 is the encouragement to be in the plan, in a meaningful way.  Many plan sponsors have gone to automatic enrollment but, unfortunately, with a fairly low default rate, maybe 3%. So making sure that individuals are saving at an adequate level and really trying to stretch themselves to maximize savings.

Also see: Employees put off by complexity of asset allocation choices

Aren’t some employers worried that defaulting employees into anything higher than a 3% deferral rate would cause employees to drop out?

Yes, but we have metrics that can reassure them that going to, say, a 6% automatic enrollment and then even an automatic increase thereafter of 1% or 2% a year up to a certain threshold doesn’t cause problems. Participants generally believe that their employer is making this decision on their behalf, [that] this is where they should be and they stick with it. Unfortunately we see only slightly over 50% of plans using both automatic enrollment and automatic deferral increases.

What if employers are just concerned about their cost due to higher matching amounts with a higher default level?

That can be a concern. But they might be able to address it if they’re willing to alter their match formula, to keep that expense pretty much constant. For example, instead of going dollar-for-dollar for up to 3%, going 50 cents on the dollar up to 6%.

As to appropriate asset allocation, most plan sponsors are opting for target-date funds as the default vehicle. Have they gone overboard?

Those funds are popular, but we’re seeing more and more plan sponsors interested in personalized advice at the participant level. So there’s a higher degree of interest in managed accounts, where we’re taking advantage of multiple data points on the recordkeeping and payroll systems to guide portfolio construction and glide paths. With a standard target-date fund, the participant’s age is the only data point. About 12% of our clients are now using it [managed accounts] as the QDIA, and I expect it to grow.

Also see: Managed accounts as QDIAs: Rare, but could change

How do those managed accounts work?

We’ve got the technology, the data and we’ve got third parties such as Morningstar and Guided Choice that have excellent services around creating those custom portfolios at the participant level. We see this really as the next evolution in the default investment area. It’s a pretty attractive opportunity and can help individuals become engaged, too, because they can then go in and add additional information with the third-party provider of the service.

Some our clients are re-enrolling the plan and moving everyone into [the] QDIA of the managed accounts, and we’re seeing only about 15% of the participants opting out and wanting to manage on their own. So the vast majority are staying in the managed account.

What kind of data apart from age is used to build participants’ portfolios?

Besides age, we know the state of residency, gender, their wages, what they’re saving, what their current balance is in the retirement account – a number of factors that we have to feed to the third-party advice provider and that’s what we use to build out those portfolios.

And when you take a look at that compared to a target-date fund, there is a pretty wide disbursement [in the] nature of the portfolios at all ages.

Also see: Retirement benefits in 2015: What employers need to know

So the participant essentially does nothing a customized portfolio is created automatically?

Participants can choose to build their own portfolios, but few are ready to invest on their own. Most know they lack the time, interest, and knowledge to do so. This is what the communication is about so they can make the right decision. That’s a very different conversation than trying to educate somebody on target-date funds, or risk-based funds, or the underlying core funds, and then picking your risk tolerance and building your own portfolio.

Can you illustrate how variables other than age, in this system, lead to different automated asset allocations?

Consider two women, both 50. One is a frontline employee on the lower end of the pay scale, and the other is an executive. The advice service is going to take into consideration the replacement ratio of Social Security as part of their wages. So for the lower paid individual, that’s going to be a much higher percentage, so maybe the portfolio doesn’t have to be as aggressive as somebody that might be an executive that has a very small replacement ratio. [They might be the] same age, maybe even living in the same zip code, but just [need] a very different mix. It could also be that that the executive has a separate deferred compensation program that’s taken into consideration.

Suppose the 50-year-old executive looks at the algorithm-based portfolio and decides she’s too light on equities. Can she change it?

She probably would have an interview with one of our professionals to share a more complete picture of her financial holdings outside of the plan. In doing so then the third-party advice provider would re-run that information and it very well could generate a different type of portfolio.

Also see: Auto features gain ground with 401(k) plan sponsors

The more information you have, the more fine-tuning. If eventually that person felt still that it wasn’t aggressive enough, she could just build and manage the portfolio on her own. Nobody is locked in; you can opt in, opt out.

Can’t this get expensive?

If you are going to use the managed account through the third-party service, you can use very low-cost funds like index [funds] and [exchange-traded funds] to help keep the cost down.

Down to what level?

For the asset management, it really varies, but it usually ranges from 40 to 50 basis points. As an individual’s account balance increases, then that is going to be tiered down in some situations. You will find some plan sponsors, too, that will want to subsidize that, so they might pay a higher recordkeeping fee to lower the managed account fee.

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And when you add on the underlying portfolio using index funds or exchange-traded funds, your all-in cost is coming in at about 65 basis points which is, quite frankly, lower than a lot of mid- to large plan total expenses.

Does that mean other plans are using a lot of actively managed funds?

The majority of plan sponsors in the 401(k) space have a pretty good dose of actively managed funds. But we’re seeing more of a trend towards fee sensitivity and a desire to drive down costs. They recognize it’s challenging at times for active managers to meet the benchmarks.

That isn’t always the case, but I think when you take a look at building out a retirement plan, you need to be cost sensitive … you need to have a balanced diversification [of] funds. Indexing makes a lot of sense. But there are certainly asset categories, like fixed income, or sectors that don’t have an index fund, where you might want to lean on more of an active approach.

Also see: 5 reasons to reconsider active management

Can the plan sponsor direct the kind of investments that can be used in the managed account service?

Yes, and overall in our business we have a very flexible platform that allows for open architecture on the mutual funds, exchange-traded funds or collective trust funds.  We have more than 50% of our clients that are using an open brokerage window, and then we’ve got multiple adviser vendors that we provide. Still, the vast majority of our clients using the managed accounts are using the underlying indexing approach, again to keep the fees down but also to create that great diversification opportunity for the managed account provider.

Is there any difference in the deferral rates of participants in managed accounts versus basic target-date funds?

Yes, being in the managed account will increase the savings rate based on the higher engagement level. The information and the feedback from the advice provider encourages that, particularly if somebody goes through one of the interviews or a consultation, which last anywhere from 45 minutes to an hour. We’ve seen individuals double their savings program typically from about 5% to 10% when they go through that type of engagement. 

Also see: Plan sponsors get serious about TDF selection

Is there any pattern to the sort of employers that are moving to the managed account as a QDIA?

It has varied a lot. Plan size does not seem to be a variable. I think it has more to do with the philosophy of the employer – do they want to embrace a more comprehensive approach to advice, are they comfortable kind of making that decision for their employees that they’re defaulting them into the advice, and being sensitive to the fees that they really want to go with a lower cost approach. 

Richard Stolz is a freelance writer based in Rockville, Maryland.

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