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.
Despite the company matches, investor education, and other perks that characterize most 401(k) plans, "the driving partner in the process was always the participant," says David Wray, president of the Profit Sharing/401(k) Council of America. "But now, the employer is really becoming the senior partner in the relationship. It will make decisions about what is considered standard unless the employee chooses something different. That's 180 degrees from the way it was. It really is a form of corporate paternalism."
With the PPA, observes Steve Utkus, principal of Vanguard's Center for Retirement Research, "Congress has jumped on the work that has come out of the private sector and academic research." Its action is based on a wealth of studies that examined employee saving patterns and offered "a more profound and subtle understanding of why people are not good planners."
Even with the government giving its blessing to automatic plans, though, Utkus still often finds corporate 401(k) investment committees a hard sell. "Philosophically, many committees are in the 'neutral vessel' mode as plan sponsors," he says. "The committee members say, 'We really don't want people in default funds; we want them to make their own choices.' The old paradigm dies hard."
Vanguard has more than 4,000 institutional clients with a total of at least 3 million participants. In the past, it has stressed automatic 401(k) features among the 1,800 of those that are record-keeping clients, says Utkus, and about 150 already have automatic enrollment and escalation components. "We'll have north of 25 percent of clients adopting the automatic approach in three years," he predicts.
Corporate education programs about employee retirement saving should get a boost from the shift to automatic plans, as the PPA intended. "When enrollment isn't automatic, there's a problem getting employees to change their behavior," he says. "Now, you'll be starting with a room full of people who are already on the right course. The education becomes supplemental, and reaffirms what they're doing. You can say, 'If you want to be more aggressive, here's how. If you want to be more conservative, here's how.'"
Consenting to Advice
Memphis-based FedEx recently announced automatic enrollment for its 120,000 401(k) participants as part of a PPA-inspired buildup of its plan. "This is something we've wanted to do for a long time," says Alan B. Graf Jr., executive vice president and CFO, who had been perplexed by the low 60 percent sign-up rate of eligible employees. "You would think a 50 percent return would be an obvious choice for employees," he says, noting the current 50 percent match terms for 401(k) contributions up to $500 currently. "We just weren't able to go far enough to educate people and help them make their savings build. Now at least we'll be starting them the other way — toward saving."
On January 1, 2008, FedEx also will sweeten the terms of its match to 100 percent of the first 1 percent of eligible earnings and 50 percent on the next 5 percent. "I'm one of those people who believes you can't save too much for retirement, given how health-care and other costs are rising so sharply," Graf says. Noting that 14,000 members of the current plan have all their retirement money in a money-market account, he is also happy that FedEx will have a diversified default-investment option. He acknowledges that increasing employees' market risk — especially after February's Wall Street shock — may take some explaining. "People say they just don't understand the market," he says, "but we think we can show them there's enough diversity in the portfolio to protect them from much of that risk."
FedEx, which has Vanguard as its 401(k) provider, is talking with various vendors about offering computer-modeled investment advice to employees, who would then be able to use a telephone hotline for more-specific guidance. It is taking its time, however, as the market for such advice programs develops.
Despite the PPA's encouragement of more advice, Fidelity and other large vendors have seemed reluctant to enter the third-party advice field. "The vendors aren't exactly doing back flips," says John Nixon, a benefits partner with the Philadelphia law firm WolfBlock. "There are tons of vendors that could provide advice, but I don't think they feel comfortable yet with the initial guidance from the Department of Labor."
David Wray says a healthy advice system already serves plan sponsors, using computer models and telephone hotlines and sometimes drawing on more-expensive face-to-face consultations. Nixon, however, believes the "advice market" could take off if a large vendor jumped in with a program.
Cost may not be as big a factor for Fidelity as the need to adjust compensation structures for its advisers if 401(k)-related advice programs were to become popular. "Right now, we are evaluating the situation," Fidelity's Cornell says.
But even as FedEx reviews advice options, its main thrust now is to communicate with employees about its reshaping of the plan in general.
"We are well aware that when you talk to people about changing their retirement savings it makes everybody nervous," says CFO Graf. "Our communication is going to be very intensive. I told our employees that we're going to answer every last question about it."
Roy Harris is a senior editor at CFO.