New Law To Expand Reach of 401(k)s
Sunday, December 23, 2007
A law making it easier for employers to automatically enroll their employees in 401(k) and other retirement plans goes into effect tomorrow.
The provision, part of the Pension Protection Act of 2006, allows companies to invest their employees' retirement savings in one of three types of funds without being held liable for losses. By absolving the companies of any liability should the investments go bad, Labor Department officials expect to clear the way for automatic enrollment. Under the new rules, employees could be enrolled in a company-sponsored retirement program unless they opt out of it.
"This is a key component of the Pension Protection Act and will help many more workers and their families build a nest egg for a secure and comfortable retirement," Labor Secretary Elaine L. Chao said in a statement.
About one-third of eligible workers do not participate in their employers' 401(k)-type plans, according to the Labor Department. Studies have shown that automatic enrollment could reduce that rate to less than 10 percent, the department said. It also said that under automatic enrollment, retirement savings could increase by as much as $134 billion by 2034.
The three fund types that employers can choose from, known as "qualified default investment alternatives," are target-date or life-cycle funds, balanced funds, and managed accounts.
Target-date or life-cycle funds shift investments over time, depending on the employee's age or target retirement date. The closer the employee is to retirement, the fewer stocks and the more bonds the fund has. Balanced funds are a fixed blend of bonds and stocks for all employees, while managed accounts are customized portfolios.
"The big event in this is that every employee is going to have the opportunity to turn the allocation decision over to someone else," said David Wray, president of the Profit Sharing/401(k) Council of America. "More people will be enrolled, and not just because of automatic enrollment but because we've made this investment decision easier."
The Pension Protection Act, signed by President Bush into law last year, sought not only to make it easier for companies to automatically enroll employees into pension plans but also to divert their money into higher-yielding investments.
Previously, employers who chose to automatically enroll employees would typically direct their money into stable-value or money-market funds, which are safer but lower-yielding, for fear that they could be sued should employees lose money. Stable-value funds account for about 13 percent of 401(k) assets, according to the research group Cerulli Associates.
Brett Hammond, head of investment strategy for the financial services organization TIAA-CREF, acknowledged that the change means that employees could take on more investment risk but said that relying on stable-value or money-market funds is "unwise."
"Life-cycle funds do have more risk than money-market or stable-value funds when it comes to returns," he said. "But money-market and stable-value funds have an extraordinarily high risk that you will not be able to support yourself in retirement."
Bradford Campbell, assistant secretary of the Labor Department's Employee Benefits Security Administration, said that the department's goal was to encourage diversified investment portfolios and that stable-value products are not optimal retirement-savings vehicles.
"Stable-value funds are a valuable component of a diversified investment portfolio, but they are not a stand-alone investment for all of a worker's retirement savings," he said.
He pointed out that employers will still be able to offer stable-value funds as options. But they will not get the legal protection if they choose to.
Considering that many Americans would rather leave the investment decision to their employers, stable-value and money-market funds could fall out of favor, to the chagrin of the insurance industry, which manages many stable-value funds.
"Plan sponsors are in the best position to understand the particular needs of their participants," said Jack Dolan, spokesman for the American Council of Life Insurers. "For certain participants, capital preservation is more appropriate than equity-based investing."
The mutual fund industry, which stands to gain 401(k) assets, applauded the decision. "The enactment of these rules is an important milestone," Paul Stevens, president of the Investment Company Institute, said in a statement. "The increasing adoption of automatic enrollment into these sensible, long-term investments will significantly strengthen the retirement preparedness of America's workers."
Edward Giltenan, a spokesman for the ICI, further explained the group's aversion to stable-value funds, as well as money-market funds. "They are not suitable as long-term savings vehicles," he said.