The Dirty Secret About Collective Investment Trusts They Don’t Tell You

The Dirty Secret About Collective Investment Trusts They Don’t Tell You

December 05, 2023

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The Dirty Secret About Collective Investment Trusts They Don’t Tell You
by Christopher Carosa December 05, 2023

Over the last decade or so, Collective Investment Trusts (“CITs”) have grown in popularity as options for 401k plans. These funds offer attractive alternatives to mutual funds. It’s not like it’s a slam-dunk decision (see “What is a ‘Collective Investment Trust’ and Does It Make Sense for a 401k Fiduciary to Use One?”, March 31, 2015).

What are CITs and why are they so popular?

“Here is the standard comment on that question,” says Lawrence (Larry) Starr, Executive VP at Cornerstone Retirement/QPC in West Springfield, Massachusetts. “CITs are only available to qualified defined contribution, defined benefit, and pension plans, and they have fewer regulatory restrictions, lower operating expenses, and more flexible pricing compared with mutual funds. CITs can invest in a variety of asset classes and in other investment vehicles. More plan sponsors are offering CITs as a complement or investment alternative to mutual funds.”

While that may be the “standard” definition, that doesn’t tell the full story.

“They are less expensive,” says Nevin Adams, an industry thought leader currently residing in Manassas, Virginia. “They certainly can be but aren’t necessarily.”

There’s a reason why CITs don’t suffer from the same regulatory onus as mutual funds. Mutual funds operate under the 1940 Investment Company Act. As such, they are regulated by the SEC. CITs fall under the jurisdiction of banking laws with state or federal regulators overseeing them.

“This can be a double-edged sword however as some in the industry have concerns over the fiduciary implications,” says Richard Bavetz, investment advisor at Carington Financial in Westlake Village, California. “While the employer is still on the hook as the fiduciary, CITs have sub-advisors so there is a degree of separation. Often used by public agencies, CITs have tighter round-trip controls placing a 30-day limit on changing funds that is quite restrictive.”

Unfortunately, because they appear similar, some incorrectly assume there’s no practical difference between CITs and mutual funds. This is not correct. Which leads us to the dirty little secret they often don’t tell you about.

“A common misleading notion is that Collective Investment Trusts (CITs) and Mutual Funds are fundamentally the same,” says Harold Evensky, founder of Evensky & Katz in Miami, Florida, and Lubbock, Texas. “While both are pooled investment vehicles, CITs are typically exclusive to retirement plans and offer lower fees, but they lack the transparency and regulatory oversight of mutual funds. Mutual funds are available to a broader audience and offer more investor protections and disclosure requirements.”

In addition, CITs can only be offered within the confines of a trust relationship. That means the plan itself might be structurally different than one that has an investment menu limited to mutual funds.

In the end, there are pros and cons to both CITs and mutual funds.

Kendall Meade, a financial planner at SoFi in Charleston, South Carolina, outlines these pros and cons as follows:

The positives for CITs, include, says Meade, “More flexibility in what they can invest in, potentially lower cost options, and the fact they are tax-exempt.” Conversely, Meade says the negatives of CITs are that “they are only available in certain plans and you may be unable to roll over into IRAs.”

Regarding mutual funds, Meade cites the pros as “they are available in any investment account and they are easier to rollover.” On the flipside, Meade says the cons include “they may be a higher cost and there may be fewer alternative investment options available.”

As with other investment decisions, the decision to choose CITs is a matter of due diligence on the part of 401k plan sponsors.

Christopher Carosa is an award-winning online news producer and journalist. A dynamic speaker, he’s the author of 401(k) Fiduciary Solutions, Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA, and several other books.