Personalized Offerings Gain Traction Across DC Plans

Defined contribution plans are in a period of transformation that’s embracing a focus on individual participants’ needs and circumstances, versus those of the broad plan population, as they prioritize employees’ retirement readiness. “Personalization is the key factor. Data can now provide a much clearer picture of the individual,” said Julie Varga, senior vice president, investment and product specialist at Morningstar Retirement.

With more data available on individual participants’ demographics and financial situation, plan sponsors are looking to adopt investment options that can more precisely match each employees’ retirement goals. Until recently, target-date funds — the default option in a majority of DC plans — did not offer much personalization beyond a participant’s age. That meant, “someone who isn’t like me and in another industry but just happens to be my age is going to be invested the same way in a target-date fund,” Varga said.

Today, however, a more flexible, tailored approach is being pursued through the use of hybrid offerings as well as adviser managed accounts, she said. In fact, both sponsors and employees are asking for increased personalization — a trend that Morningstar Retirement is seeing at DC plans of all sizes, though the larger plans tend to be the first adopters.

Managed accounts flourish  
“We are seeing an evolution in default options and an increase in the use of hybrid approaches,” Varga said, where managed accounts are able to provide the personalized elements. In a hybrid arrangement, a younger participant is defaulted into a target-date fund and then moves into a managed account as they age. “As people get older, their situations become more complex. Managed accounts are positioned to help participants invest based on their unique situation,” she noted.

Personalization Factors for Managed Accounts       
Source: Morningstar Retirement

Another area of growing interest is adviser managed accounts that have “been an essential enhancement to managed accounts, because they bring advisers into the fold,” she said. The adviser creates the underlying or model investment portfolios for the retirement program. Then, a portfolio-assignment engine is used to make recommendations for participants’ asset allocation tailored to their individual needs. “Our adviser managed accounts methodology determines that equity-fixed income split and, based on a number of factors, we then use the portfolio(s) created by the advisory firm to slot in the investments,” Varga said.

As part of its adviser managed accounts service, the firm offers a user interface that provides tailored advice for different participants based on the latest research. For instance, it aids decision-making for younger participants who often lack guidance on appropriate savings rates. “Taking factors such as income, certain expenses and taxes into account, the interface suggests what they should be saving,” Varga said. Each participant can view their projected path to reaching retirement goals if they were to use recommended savings levels in combination with the managed accounts service. “It’s crucial for younger individuals to understand the impact of savings.”

READ: How to Evaluate Managed Accounts as a QDIA 

Adding flexibility            
While short-term shifts in macroeconomic drivers typically do not impact DC investment menus, having a more custom target-date fund or suite of managed accounts could provide plan sponsors with flexibility in implementing changes, Varga said.

“DC plan sponsors take a longer-term approach, and they don’t want to overcomplicate menus with strategies that address short-term issues like volatility,” she noted. But given the current shift in the interest rate cycle, more sponsors are interested in diversifying the fixed income offerings on the plan menu. That might not be possible in an off-the-shelf target-date fund, she said. “Plan sponsors don’t necessarily have an option around diversification of fixed income in a TDF. It’s up to the fund company.” In contrast, a custom target-date portfolio or managed account can offer sponsors the flexibility to change sub-asset classes, such as adding Treasury Inflation-Protected Securities if they have inflation concerns.

When it comes to alternatives such as private equity, private credit and real estate, DC plan sponsors continue to be wary of including them as a core option because “they don’t want individual investors to inappropriately allocate to alternatives,” Varga said. Alternatives might be offered as a noncore option, but only with strict guardrails in place. “Those types of asset classes could be available to a professional investment manager in a custom target-date or managed-account setting, but they couldn’t be used outside of that,” she said, noting these assets require significant and ongoing fiduciary oversight.

Holistic wellness      
The personalization trend in DC plans is also expanding beyond investment services to financial wellness offerings that take a more holistic approach to a participant’s financial situation and needs for retirement security. For the savings phase, DC plans are evaluating or offering programs to tackle student loans and credit card debt. “Many plans provide personalized and holistic advice to their employees beyond the retirement plan,” Varga said.

Morningstar Retirement is developing offerings that provide holistic wellness services, typically delivered in the form of a robo-offering. “We are creating methodologies where we can suggest where your next dollar should go. It’s not necessarily straight to the retirement plan, it might be to an emergency savings account,” she said.

READ: Unique Opportunities With Managed Accounts

Spending down      
As plan sponsors take on the challenge of maximizing retirement income for participants in the decumulation phase, customized advice is getting more granular. “Participants are looking for advice around how they should be spending down pools of assets. They’re trying to understand when to take Social Security. They want to be tax aware, and [know] how they should be investing their remaining assets,” Varga said.

Morningstar Retirement’s managed account offering includes a decumulation service for spenddown. “The service doesn’t necessarily have to be attached to a guaranteed product, although that can be an option. A personalized and holistic recommendation would be made to determine first whether the individual needs guaranteed income based on their data,” she said.

For example, a participant with an existing pension may not need additional guaranteed income in retirement. For those that do, the advice could determine how much to allocate to the guaranteed solution, she said. “The key is personalization — understanding that person and their lives, whether they need some sort of a guaranteed option and if so, how much?”

Data transformation     
“Ten years ago, we didn’t receive much data from plan providers, but that has advanced dramatically. Today we’re receiving between eight and 15 data points for each participant,” Varga said, adding that the ongoing data evolution will continue to drive DC plan personalization.

While data availability is partially dependent upon the record keeper, Morningstar Retirement has the capability to pull data from other sources such as payroll providers. “We are constantly looking at ways to innovate and get more information,” she said. Morningstar, Inc.’s proprietary data aggregation platform, ByAllAccounts, is accessible through adviser managed accounts and can provide advisers with data about their client’s held-away investments that helps them further personalize their retirement recommendations. “Even in a default setting, when managed accounts are the [qualified default investment alternative], we have enough information about each individual to provide a personalized recommendation,” she said.

Regulatory developments and their impact on QDIA selection are another key area of focus at the firm. “We found that there was a lot of information about target-date funds, but not much about the process for deciding if managed accounts might be more appropriate,” Varga said, particularly given the greater interest from advisory firms to offer adviser managed accounts as the default offering. To that end, Morningstar Retirement has worked with outside counsel to draft a memorandum detailing a process for plan fiduciaries interested in selecting managed accounts as the QDIA. It lists factors that can support a prudent selection process, including questions to ask providers, type of documentation and ongoing due diligence issues.

With the DC industry’s growing recognition of the need to address individual participants’ financial situations in a holistic way, customized products and advice will continue to meet that need. “Hybrid QDIAs that move participants from target-date funds to managed accounts, along with adviser managed accounts, are all going to continue to gain traction,” Varga said.