The future of 401(k) plans: Personalized target date funds, advisor managed accounts

A new white paper from Wilshire, a consulting and investment technology firm, says the future of defined contribution (DC) investing is a more personalized model, featuring an evolution of Target Date Funds (TDFs) and managed accounts.

“We believe the future of DC will increasingly be defined by personalized investing, whereby the boundaries separating TDFs, and managed accounts will fall away,” the white paper said. “We believe these emerging innovations will amplify demand for and market share of managed account-powered solutions as retirement plans and their participants demand more personalized portfolio solutions.”

The report offered an overview of the way DC investing has changed over the years and predicts a further evolution in the future. It showed how federal regulations and market changes have combined to bring us the DC plans we know today, and how current trends are pointing to a more personalized approach in the future.

Regulatory changes heralded the rise of DC

“At their genesis, 401(k) and other DC plans were likely not envisioned to be the principal means by which Americans save and invest for retirement,” the white paper noted. “Certainly, their cost, design and use would not lead to that conclusion, even several decades after they launched following the passage of the Employee Retirement Income Security Act (ERISA) in 1974 and the Revenue Act in 1978.”

The paper said the decline in use of defined benefit (DB) plans after 1980 led to the rise of DC plans—however, the limitations of the early DC plans emerged quickly. With DC putting the decision-making more in the hands of employees, it become clear that most Americans did not know much about investing and saving for retirement.

“The vast majority of plan participants are not investment professionals, but were treated overnight as if they were,” the report said. “By the late 1990s and early 2000s, it became increasingly clear that many employees would simply fail to take appropriate, proactive measures on their own to enroll in their employer-sponsored DC plans, save an adequate amount of their paycheck, or invest in a diversified portfolio appropriate for their age and financial circumstances.”

With the passage of the Pension Protection Act in 2006, Congress tried to address the problem by using automated features and default investment models. These measures have eased the complexity to a degree, but many complex issues remain for Americans trying to save for retirement.

TDFs, CITs, etc.

The paper noted how the PPA provided three types of investments as defaults: TDFs, balanced funds, and managed accounts. “While all three options bring professional investment management to DC plan participants, TDFs are overwhelmingly selected … by most plans today, accounting for more than 98% of all such plan sponsor elections,” the report said.

But TDFs are clearly in need of further enhancement, the white paper argues, with not enough customization provided, especially given the economic turmoil that American investors have recently seen.

“Inflationary shocks experienced following the pandemic and unprecedented monetary and fiscal intervention exposed weakness in portfolio design,” the report said. “We would like to see incorporation of additional real asset strategies to improve portfolio resiliency in the face of inflation.”

The need for more flexibility and diversification has been seen in account plan designs for years, leading to things such as master trusts, multiple plan offerings, and collective investment trusts (CITs).

A move toward managed accounts

The paper argues that the emergence of models that allowed portfolios to be customized by age, financial circumstance, and risk tolerance have led to a dominant growth of managed DC plans. “Availability of managed accounts in DC plans grew from 6% of plans in 2005 to 59% of plans in 2019. We anticipate this trend to continue, likely eclipsing an 80% adoption level before 2030.”

Related: Digitized, personalized financial wellness: Meet 401(k) plan participants where they are

The paper said the future of DC will be a move to personalized investing models and hybrid models of earlier types of plans. It also details the rise of models like advisor-managed accounts (AMAs). “[The AMA approach] is distinctly positioned to not only tailor investments to better meet plan sponsor needs and preferences, but also amplify the role and value of the advisor, who will increasingly provide advice not just at the plan but also participant level,” the report said.

More recent regulation, like the SECURE 2.0 Act will result in further changes, the paper said. The focus in coming years may be lifetime income and funding lifestyles in retirement years.

“Until now, plan sponsors, participants and consultants have all focused predominantly on how to save and invest enough to retire – but planning only to retirement rather than through retirement can cause participants to either spend too little and fail to fully enjoy their retirement savings or, alternatively, spend too much and ultimately be forced to dramatically curtail spending or altogether exhaust their savings in retirement,” the white paper said.