New 401(k) Auto-Enroll Rules To Start

The new regulations mainly aim to help workers who have benefited the least from 401(k) plans.

The new regulations make it easier for companies to automatically enroll employees in their 401(k) plans. The idea is to give a nudge on their way to retirement saving to those workers who either don't choose an investment in their plan or who don't even sign up to join.

To accomplish that, the rules also spell out which types of investments 401(k) plans can automatically funnel workers into.

"The new rules flip-flop the way things used to be done," said Ann Combs, head of retirement policy, research and consulting for Vanguard Group. "Before, a worker had to say that he wanted to join a plan. Now a plan can choose to automatically enroll everyone. A person can still not participate, but he has to opt out."

The new rules, which take effect Dec. 24, grease the skids for auto enrollment by providing legal protection for plans that use it. The rules also provide a legal shield for plans that use one or more of three specified options as their default enrollments: lifecycle or target-date funds, balanced funds and managed accounts.

"Plans can use one or more," Combs said. "But generally plans will choose just one. That way, they don't have to spend time and energy deciding which option to use for different people. And they won't have to defend how they decided which option to use for various people."

The legal protection is known as safe harbor status. Basically, a worker who is auto-enrolled into a default option will be barred from suing the company if he doesn't like how the investment performs.

Shift Responsibility

"The plan sponsor or company won't be held responsible," said Jeff Maggioncalda, president of Financial Engines, which provides investment advice and managed accounts to 401(k) plans. "The rules shift responsibility onto the plan member. They deem it's as if the plan member had chosen to join and had chosen that investment. Plan members must be given periodic notice. And by not opting out or making changes, it's as if they selected the options."

Auto enrollment helps boost participation in plans. About 24% of plans had adopted it as of last year, according to the Profit Sharing/401(k) Council of America. That was up from 7% in 2002.

Without auto enrollment, plan participation had plateaued in the 70% range. "That was steady for years," Maggioncalda said. "But when plans automatically enroll workers and let them opt out if they want to, rates go into the 90s."

The people who don't join or don't choose an investment typically doubt they can make a good investment choice, Combs says. "The new regs put them into position to save for retirement," she said. "This is a very positive development."

The nature of the default investments is crucial because many people tend to stay for years, even decades, in their initial investments.

Knowing that, the Department of Labor said default options must meet three criteria. They must be diversified. They must be able to generate reasonable returns over time. And they must not financially penalize members for opting out.

The defaults that DOL chose satisfy those requirements:

Lifecycle or target-date funds, whose mix of stocks and bonds varies, depending on a worker's age, retirement date and risk tolerance.

Balanced funds, which offer the same mix to all employees.

Managed accounts, which provide advice and portfolios tailored to each worker from a plan's menu of investment options.

DOL did not green-light money market funds and stable value funds, which many plans had been using, for use as defaults.

"They're basically cash equivalents," Combs said. "Historically they haven't grown enough over time. And many impose penalty fees on people who exit early."

Plans can still offer money accounts and stable value funds as nondefault options.

Beefing up participation in 401(k) plans is especially important in view of falling availability of traditional pension plans.

Of companies that have already barred new hires from their pension plans, 59% have adopted auto enrollment in their 401(k) plans, according to a July study by the Employee Benefit Research Institute. And 61% that plan to close their pensions within two years have auto enrollment in their 401(k)s.