What are subaccount unit values and mutual fund net asset values?

Before we can define subaccounts, unit values, and NAVs in mutual funds, we need to first discuss the companies that offer the accounts that hold them—retirement plan recordkeepers.

Retirement plan recordkeepers: insurance companies versus trust companies

The Employee Retirement Income Security Act of 1974 (ERISA) requires that retirement plan assets be held in a trust (with few exceptions) to protect the assets of plan participants, should their employer go out of business. To do this, recordkeepers will take different paths based on whether they’re insurance companies or trust companies.

Trust companies are legal entities that act as custodians and trustees to the retirement plan assets they hold (among other duties). Trust companies place the plan’s assets in a trust they manage and are responsible for distributing plan assets to beneficiaries when the plan sponsor instructs them.

Insurance companies take a slightly different path because they can’t create and own a trust or act as trustees; instead, an insurer issues a group annuity (GA) contract to a trust company. The trust company then creates a trust to be the legal entity. The plan sponsor’s decision makers act as the trustees and have the same governing authorities as they would if they were working with a trust company.

Now we can help answer: What are subaccounts?

So, what does this background on trusts and GAs have to do with investment values being different? Participants in retirement plans purchase investments, but the type of company holding the assets affects how the investment is owned. In a trust company, the participant purchases the actual shares of the investment, such as a mutual fund, directly. In a GA contract with an insurance company, however, participants choose their investment but actually buy units of a subaccount, which will use the money to invest in—for example—the mutual fund. Because it’s not a direct ownership, the subaccount layer can create a variance in value.

What’s the net asset value of a mutual fund?

A mutual fund’s value is called its NAV, the price at which investors purchase or sell shares, similar to a stock’s share price. NAVs are calculated at the end of each day as follows:

NAV = (Assets – liabilities) ÷ Total number of outstanding shares

If a mutual fund owns $2 million of stocks and has no liabilities, and there are 200,000 shares outstanding, the NAV for that day would come out to $10 per share. 

NAV = ($2,000,000 – $0) ÷ 200,000 = $10

If the mutual fund decides to distribute a $2 dividend per share to investors—a liability to the mutual fund—the NAV will decrease by the amount of the dividend per share. Since the investor receives $2 in a cash dividend from their mutual fund, the value of their mutual fund will decrease by $2, to $8.

NAV = ($2,000,000 – $400,000) ÷ 200,000 = $8

Examples are for illustrative purposes only.

What’s the unit value of a subaccount?

Participants in a GA contract legally can’t invest directly in mutual funds. The subaccount serves as the intermediary to enable participants to invest in the mutual fund they want to own. Participant contributions to their retirement account purchase units of the subaccount, which invests in the advertised mutual fund. It’s a nuanced distinction that gets to a similar result as a retirement plan offered by a trust company.

You calculate the unit value of the subaccount very similarly to the NAV of a mutual fund:

Unit value = Market value of assets in subaccount ÷ Total number of outstanding units

Example is for illustrative purposes only.

For many retirement plans, the asset in the subaccount is a single mutual fund. The numerator represents the current share price of the mutual fund multiplied by the number of mutual fund shares in the subaccount. Divide that amount by the number of subaccount units owned by plan participants. The plan creates more units as participants contribute more money to their account, increasing the numerator and denominator. 

Two situations when unit values differ from NAV

We still haven’t shown how unit values and NAVs can deviate from each other, but let’s go through a common scenario to show how this can be. 

A mutual fund distributes a dividend

If a mutual fund with a $10 NAV distributes a $2 dividend to investors, the NAV after the dividend payment decreases to $8. The math above supports this. 

The unit value of the subaccount holding the same fund doesn’t change and remains at $10 (assuming the unit value matched the NAV when we started). How can that be? Let’s lay out a scenario:

A retirement plan has 100,000 units of a subaccount valued at $10, making the market value of the subaccounts’ assets $1 million. The $1 million is invested exclusively in mutual fund ABC with an NAV of $10 (per share). Mutual fund ABC pays out a $2 per share dividend, reducing ABC’s share price from $10 to $8. 

The subaccount—not the participant—is the owner of the shares and recipient of the dividend. Since the subaccount invests in mutual fund ABC, it uses the $200,000 ($2 dividend times 100,000 shares in the subaccount) to buy 25,000 more shares of mutual fund ABC ($200,000 divided by $8 share price). That happens instantaneously (i.e., the subaccount never receives cash, only additional shares of mutual fund ABC). At this point, the unit value hasn’t changed because the market value of the shares (the numerator) is the same, and the number of units hasn’t changed.

Before the dividend payment

Unit value = Market value of assets in subaccount ÷ Total number of outstanding units

Unit value = (100,000 ABC shares x $10) ÷ 100,000 subaccount units = $10

After the dividend payment

Unit value = Market value of assets in subaccount ÷ Total number of outstanding units

Unit value = (125,000 ABC shares x $8) ÷ 100,000 subaccount units = $10

There are a couple points worth reiterating:

• Dividends don’t affect the unit value of a subaccount, although the unit value may still change on the day of a dividend due to market fluctuation
• Subaccounts, not plan participants, are the recipient of dividends, which are automatically reinvested to buy more shares of the mutual fund at its post-dividend NAV (for the subaccount)

Subaccounts increase their mutual fund shares to offset the lower NAV following a dividend. This process also occurs when a mutual fund does a share split. If the mutual fund above did a four-for-one share split, the NAV would drop to $2.50 since there are four times as many shares (i.e., no change in market value). The subaccount would increase its holdings to 400,000 shares so that the total market value ($1 million) remains the same. 

Examples are for illustrative purposes only.

Subaccounts and mutual funds—tomatoes and tomahtoes

A mutual fund with a higher NAV than the unit value of the subaccount holding the mutual fund doesn’t make it any more or less valuable. The value for both depends on the performance of the fund itself. Similarly, a retirement plan recordkeeper that’s a trust company isn’t better or worse than one that’s an insurance company. What generally gives the recordkeeper value is the products and services it offers. 

Try not to spend time worrying about the differences in prices between unit values and NAV. Rather, consider spending time evaluating the underlying investment and whether it’s meeting your expectations.