Since the launch of the 401(k) in 1982, participants have been required to make most of the major decisions about funding and managing their plans themselves. Twenty years of evidence shows they nearly always do it badly, but until now the law prohibited plan sponsors from offering all but the most cursory advice.
No more. Passage of the Pension Protection Act (PPA) last August gave plan sponsors strong incentives to build a range of automatic enrollment, escalation, and rebalancing features into their 401(k) plans, along with a default selection of investments. Since 401(k) and other defined-contribution plans now serve 84 percent of all U.S. employees who have corporate retirement plans, the PPA in effect restores some of the paternalistic employer management characteristics of the defined-benefit era.
The added burden may be worth it. The PPA provides employers with a fiduciary safe harbor that increases their comfort level in taking a more active role in employee retirement planning. Currently, as much as 20 percent of plans automatically enroll employees; employees must opt out of a plan to avoid participating. About 15 percent of those plans provide for automatic increases as salaries rise. With the impetus from the PPA, those percentages are likely to climb sharply in the next several years, especially among plans with fewer than 1,000 participants.
“From the employers’ perspective, there’s no reason to wait, now that they have clear fiduciary operating guidelines and a safe harbor,” says Jamie Cornell, senior vice president of employer marketing for Fidelity Employer Services Co. He already sees a change in employer attitude among Fidelity’s plans. (With 13 million total participants and 20,000 corporate plans, Fidelity is the largest plan provider.) Fidelity, a big winner when plan participation grows, is pushing hard for more plans to join what it calls “the next generation” of retirement savings.
The PPA also sets guidelines under which companies can arrange for individual advice to be offered about retirement investing. “The early adopters of automatic enrollment are celebrating the fact that they’ve seen 90 percent and 95 percent plan-participation rates,” adds Cornell, comparing them with more-typical rates of 60 percent or so in the past. “Now they’re using the plan’s design to influence participant behavior” and boost savings. Some sponsors, for example, are requiring participants to contribute at least 6 percent of salary to qualify for a company match of invested dollars. This amounts to doubling the average deferral rate. Fidelity’s goal is to raise the average deferral rate to 6.9 percent. “We’d like to see people eventually saving upwards of 10, 11, or 12 percent toward retirement,” says Cornell. Among current participants in plans, Fidelity calculates, 92 percent don’t maximize their contributions and 86 percent don’t rebalance their accounts from year to year.
A Paradigm Dies Hard
The rationale behind this dramatic reform of the retirement-savings system involves making inertia work for employees, whose biggest problem has been failure to sign up for a plan. “Adding the automatic enrollments should bring participation percentages into the high 90s for any sponsor,” says Robert Liberto, senior vice president at Segal Advisors, the investment consulting arm of Segal, and a provider of investment services to corporate and public-sector pension-plan sponsors.