You may have heard of a collective investment trust, but what is a CIT, exactly? Also known as a commingled trust or collective trust fund, a CIT is a pooled investment fund that’s similar to a traditional mutual fund — but a CIT falls under a different regulatory path and may offer lower fees and tax advantages.
Similar to a mutual fund, a collective investment trust generally consists of assets pooled from investors — but in the case of a CIT the funds come only from qualified, employer-sponsored retirement plans, such as 401(k)s, pension plans, and government plans. They are typically not available to retail investors directly. So, while you might find a CIT available to you through a work-sponsored retirement plan, at the moment you couldn’t invest in one directly through your personal IRA, say.
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That said, CITs have grown in popularity in the last few years, owing to their lower cost structure and potential tax advantages. CIT’s are increasingly pervasive on the fund investment landscape. According to industry figures, the percentage of plan sponsors offering collective income trusts rose to 78% in 2020 from 44% in 2011.
Let’s take a closer look at how CITs work, and what they may offer investors.
How a Collective Income Trust Works
The goal for a collective income trust is to pool fund assets together into a single account (called a “master trust account”) and manage the investment funds in a highly diversified, low-cost manner. Although the trust is typically managed by a bank or trust company, the trustee can opt to hire an investment management firm in a sub-advisory capacity to manage the income portfolios.
The CIT investment process is fairly standard. Structurally, the bank or trust company will collect funds from various retirement-oriented investment accounts and commingle them into a single fund (i.e., the CIT), and thus become the trust’s “owner.” CIT investor participants don’t own any direct assets in the trust – instead they hold a participatory interest in the CIT fund assets (similar to the way investors hold mutual fund shares).
The trust, meanwhile, is free to invest in a wide variety of investment vehicles, including stocks, bonds, mutual funds, currencies, derivatives, or possibly alternative investments like commodities or precious metals. Strategically, the trust manager’s mandate is two-fold:
1. Collect investment assets from participating investment plans and commingle them into a single fund.
2. Manage the single fund like any mutual fund manager does – with a specific investment strategy, and goals and track the fund’s performance to ensure the fund is meeting its investment goals.
Collective Income Trusts vs. Mutual Funds
CITs are often compared to mutual funds because in both cases, investors’ assets are pooled and invested in a diversified portfolio of securities. Other than that, these two investment vehicles have some stark differences.
• Individuals can invest in a mutual fund through an online brokerage or a personal retirement account like an IRA, but investors can only access CITs through an employer-sponsored retirement plan, pension plan, or insurance plan.
Earlier this year, a bipartisan group in Congress pushed for reconsideration of the Public Service Retirement Fairness Act, a law that could change rules pertaining to 403(b) plans, typically used by teachers and other civil servants, to allow CITs as investment options in those plans. Those efforts are still underway.
• A collective investment trust is not regulated by the SEC but overseen by the Office of the Comptroller of the Currency (OCC) for national banks or state banking authorities for state banks and the Department of Labor (DOL). As a result, a CIT is typically less transparent about its holdings.
• Unlike a mutual fund, a collective income trust is not required to register under bylaws created in the Investment Company Act of 1940. Thus, because a collective investment trust isn’t subject to the same operational, disclosure, and reporting rules of federal and state securities laws, the cost to invest in a CIT is generally lower than a mutual fund.
• Whereas mutual fund fees are set by the investment firm as an expense ratio and are non-negotiable, some CIT costs can be negotiated.
• CIT earnings are considered a tax exempt investment, not merely tax deferred as mutual fund earnings within an employer-sponsored plan might be.
• A collective investment trust is set up as a trust and offered by a bank, trust company or other financial institution, whereas a mutual fund is offered by an asset management company.
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A History of Collective Investment Trusts
Collective income trusts have been around for nearly a century. The first fund rolled out in 1927 on a limited basis. When the stock market crashed in 1929, CITs fell under additional scrutiny owing to the pooled nature of these funds, their lack of transparency, and the timing of the crash. Subsequently, CITs were significantly restricted by the government, which mandated that CITs could only be offered to trust company clients and through employee-sponsored retirement plans.
About 20 years ago, though, CITs began providing daily valuation and standardized transaction processing — in other words they began to operate more like mutual funds — which greatly increased adoption by defined contribution plans.
The real turning point came in 2006, when the Pension Protection Act provided for the use of Qualified Default Investment Alternatives (QDIA) for certain 401(k) plan investors. Target date funds, many of which include CITs, were designated as QDIAs, thus giving more investors access to CITs (although banks and trusts still couldn’t, and can’t, offer CITs directly to retail investors).
Since then, the cost efficiency of collective investment trusts has drawn the attention of many fund managers, and the use of CITs over traditional mutual funds in target-date fund series is growing, according to research company Morningstar’s analysis, with 43% of target fund assets invested in CITs at the end of 2020.
Collective Income Trusts: Things to Know
By design, collective income trusts offer several unique features — and potential drawbacks — for qualified retirement plan providers and their investors:
CITs as fiduciaries
CITs must abide by the rules and regulations laid out in the Employee Retirement Income Security Act of 1974 (ERISA). That means CITs must meet minimum standards of conduct, like requiring CIT providers to give investors critical information such as plan features and funding. As such, a CIT trustee is held to ERISA fiduciary standards for the ERISA plan assets invested in CITs.
CIT’s long-term focus
Unlike a mutual fund, a CIT doesn’t have to distribute 90% of its taxable income every year (mutual funds are regulated investment companies and are required to provide annual taxable income distributions to investors.) That allows collective income trusts to hold investment funds in the trust, allowing those investments to grow in value over time.
No FDIC coverage
Unlike bank deposits, investor deposits in a collective income trust are not insured by the Federal Deposit Insurance Corporation (FDIC). While investments in a 401(k) are not FDIC-insured either, if deposits (e.g. savings, money markets, CDs) are covered by an FDIC-insured institution, then the deposits are as well.
CITs and rollovers
Collective income trusts don’t offer the same investment portability of mutual funds. Trust customers have to liquidate their positions in the CIT into a cash account before they can roll over funds adding an extra step to the account rollover process. Thus, CIT investors should work closely with their plan sponsors when rolling plan funds over to another retirement plan.
Now that we’ve asked, What is a CIT?, it’s time to recap this intriguing and little-known investment option. Although a collective investment trust is often compared to a mutual fund, the only two similarities of these vehicles is that they are both pooled investment portfolios, with funds from many investors commingled — and both are used in retirement plans.
For now, though, a CIT is only available to investors through certain qualified plans, including 401(k), pension, and government retirement plans, in addition to qualified profit-sharing and stock-bonus plans. Collective income trusts are becoming more common in the employment retirement plan universe, as more target date funds opt to include CITs. And there is bipartisan support in Congress for rules that would allow 403(b) plans to include collective investment trusts as an option for plan participants.
Other than that, CITs are really quite different from mutual funds. They follow a different regulatory flow and are not overseen by the SEC. With more room to operate in a regulatory sense than traditional mutual funds, CITs can offer clients a unique long-term investment option tailored to their investment management needs, and in a cost-effective manner — all managed in a single investment account.
Investing in a CIT through your company retirement plan does not preclude other investments, like setting up a SoFi Invest® account to invest directly in stocks, bonds, or ETFs — or open your own IRA online. In addition, becoming a SoFi Member gives you complimentary access to advice from professionals, who can help you consider how different retirement choices might work in your long-term plan.
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