Why a CIT?
CITs for 401(k)s have become popular because (sometimes) they offer several advantages over other investment vehicles, such as lower fees, transparency, tax efficiency, and flexibility. The word ‘sometimes’ is used because a CIT is not always the best solution for a retirement plan option. Due to the structure of CITs, an employer tax-qualified plan like a 401(k) is the only way that you can participate in a CIT. From a plan sponsor’s standpoint, it is important to know that a CIT may not be able to be placed in your company’s retirement plan without significant changes to the plan’s design.
Choosing suitable retirement plan investments can be daunting for those selecting the investment options for the plan and the participants. One investment option that has gained traction in recent years is Collective Investment Trusts (CITs). In this guide, I will introduce you to CITs, their differences, and why they are becoming attractive for retirement investors. But note that they will not work in every circumstance. That will be discussed further in this article.
Understanding Collective Investment Trusts (CITs)
CITs or Collective Investment Funds (CIFs) are tax-exempt pooled investment options that qualify for inclusion in ERISA-qualified retirement accounts. Unlike mutual funds, which individual investors can directly purchase, CITs can only be in an employer retirement plan.
CITs are maintained and managed by trust companies or trustee banks, who use the combined power of investor funds placed into retirement plans to purchase a diversified portfolio of securities. These securities can include stocks, bonds, commodities, and many other investment options. One of the most popular uses of CITs is for target date funds.
Differences of CITs for 401(k)s versus Mutual Funds
While CITs and mutual funds share similarities, there are several differences.
Lower Costs
For now, one of the significant advantages of CITs is their potential for lower costs compared to mutual funds. This cost advantage is primarily due to the regulatory differences between the two investment vehicles. The Securities and Exchange Commission (SEC) regulates mutual funds and sets processes and filing requirements. Regulatory obligations can increase the operating costs of mutual funds. In turn, individual investors pay any extra fees. On the other hand, CITs are regulated by the Office of the Comptroller of the Currency (OCC) and state-level banking regulators, resulting in lower administrative and operational costs.
But don’t expect this difference to be significant or last forever. The cost of regulation is an ever-changing part of investing. The competitive nature of the market drives change. If the mutual fund providers are losing out to CIT providers due to regulations, look for those circumstances to change. However, for now, it may be an advantage. Another point that you will notice is that most major mutual fund providers also provide CITs.
Flexibility can Carry Risk
Much of the information available on CITs for 401(k)s will tout the investment flexibility of CITs as a significant advantage, giving you the possibility of higher returns. But remember, where there is a greater return, there is also a greater risk. The popularity of CITs may lead some investors into investments that are riskier than they realize. Mutual funds are subject to many regulatory requirements that restrict the types of investments they can include and their strategies. If you are a trustee responsible for the investment selection of a 401(k), limiting the risk of some investments may be in the best interest of your employees. Like any other plan investment, you should monitor their appropriateness reguarly.
If you are a trustee for a retirement plan, remember that it is your responsibility to monitor the risk of the investment options. You must understand the risks if you offer a CIT with a broad ability to concentrate investments or invest in investment derivatives.
Overall, CITs offer more operational flexibility than mutual funds. The flexibility allows CITs to pursue different investment strategies and possibly achieve better results but at a greater risk. Additionally, CITs can provide plan sponsors access to alternative investment strategies that may not be available in mutual funds. There again, alternative investment strategies often do carry additional or unknown risks.
Fiduciary Standards and Oversight
CITs for 401(k)s are promoted as adhering to higher fiduciary standards since they are responsible for ERISA guidelines. This assertion is not entirely true. The Fiduciary standard is not higher. It is different.
The SEC fiduciary standard follows a principles-based approach, while the DOL fiduciary standard adheres to a rules-based system. For tax-qualified retirement plans, the SEC fiduciary standard may require the trustee to disclose more information to the plan sponsor and participants about their fees, services, conflicts of interest, and investment strategies.3 Conversely, the DOL fiduciary standard may require the trustee to provide more documentation and evidence to justify their compliance with the rules.4
Portfolio managers or teams can manage both CITs and mutual funds using the same investment process and methodology for both vehicles. However, there may be differences in how they implement their strategies, such as portfolio construction, trading, rebalancing, and tax management. 2
Transparency and Public Information
Mutual funds provide public information such as daily net asset values (NAVs) and ticker symbols, which allow investors to track their investments easily. In contrast, CITs do not have publicly available fund information or ticker symbols. However, participants can typically access information about their CITs through designated web portals established by their recordkeepers or plan sponsors.
The lack of transparency and public information deters some participants because they like keeping track of their investments with budgeting software. Programs like MINT and Quicken cannot track the values of CITs like they can mutual funds. That information must be updated manually.
Furthermore, CITs are not registered with the SEC and do not have to comply with the same disclosure and reporting requirements as mutual funds. This means that CITs may have less transparency and information available to investors than mutual funds.
It is also important to understand that CITs are priced and valued differently. Unlike mutual funds, which have a net asset value (NAV) that is calculated daily and publicly available, CITs may have different methods of determining their value and frequency of reporting. This could affect the liquidity and performance of CITs compared to mutual funds.
The Growing Popularity of CITs in Retirement Plans
In recent years, CITs for 401(k)s have gained significant popularity among retirement plan sponsors. According to a study by Callan Associates, the number of surveyed DC plans offering at least one CIT increased from 44% in 2011 to 78% in 2020. 1 This trend can be attributed to several factors, including the potential for lower costs, pricing flexibility, and availability on distribution platforms.
Plan sponsors, especially those focusing on plan expenses, are increasingly considering CITs to provide participants with a broader range of investment options while potentially lowering overall costs. The lower cost structure of CITs, combined with their flexibility and regulatory advantages, makes them an attractive choice for plan sponsors looking to enhance their retirement plans.
Implementing CITs for 401(k)s
If you are a plan sponsor considering CITs for your 401(k) plan, there are several factors to consider. First, you should assess your recordkeeper’s capabilities and ensure they can support CIT reporting services. Many recordkeepers now offer robust reporting services for CITs, making incorporating them into your plan easier.
Additionally, educating your plan participants about CITs and how to access fund information online is essential. While CITs do not have publicly available fund information, participants can typically access information through designated online portals provided by their plan sponsor or recordkeeper.
Finally, working closely with your recordkeeper and investment advisor is crucial to select the most suitable CITs for your plan. Consider factors such as investment objectives, risk tolerance, and the specific needs of your participants.
The Final Word on CITs for 401(k)s
Collective Investment Trusts (CITs) offer an attractive investment option within 401(k) plans. They are very popular with PEP plans as well. With the possibility of lower costs, and flexibility, CITs have gained popularity among retirement plan sponsors. However if you are a trustee of a company retiement plan, you should also know potential drawbacks or limitations of CITs, such as minimum investment requirements, limited availability, lack of portability, and fiduciary risks. By understanding the differences between CITs and mutual funds, plan sponsors can make well-informed decisions for their retirement plans. As CITs are becoming increasingly popular, plan sponsors must stay informed.
Disclaimer: The information provided in this article is for educational purposes only and is not financial or investment advice. Plan sponsors and retirement plan participants should consult their legal and financial advisors before making investment decisions or retirement plan changes.
References
1 2022 Callan DC survey finds DC plans to keep sharp focus on fees. (2022, March 1). Callan. https://www.callan.com/blog-archive/callan-dc-survey-2022/
2 Don’t know about CITs? You probably should. (2021, November 10). Morningstar, Inc. https://www.morningstar.com/personal-finance/dont-know-about-cits-you-probably-should
3 Fiduciary responsibilities. (n.d.). DOL. Retrieved October 12, 2023, from https://www.dol.gov/general/topic/retirement/fiduciaryresp
4 Miller, S. (2021, February 18). DOL finalizes less-restrictive fiduciary standard for investment advice. SHRM. Retrieved October 12, 2023, from https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/dol-finalizes-less-restrictive-fiduciary-standard-for-investment-advice.aspx
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