GuidePost - Vol. 3, Issue 1 2007

The GRABot BAG
by Sherrie E. Grabot, CEO

January 2007
Automatic enrollment rolls onward

New year or not, anyone who scans the statistics for plan participation, savings rates, and investment choices knows that the state of retirement planning for many Americans is still pretty dire. One of the bipartisan successes of the last Congress, the Pension Protection Act, aimed to help rescue them - or more accurately, help them rescue themselves.

A particularly promising area of the PPA concerns automatic enrollment and the default accounts associated with it. This is also a somewhat mysterious area, at least to the non-lawyer. To help clear the air and point the way, ERISA attorney Fred Reish and his colleagues have recently produced a detailed analysis of what the new rules mean, and what they may lead to. It's important stuff, so for those of you who don't read legal bulletins (and frankly, I don't blame you), here are some of the "greatest hits" from this document.

Safe harbor: Get in, everyone
More and more plan sponsors are choosing to implement automatic enrollment for new participants. It's already legal. So the point of the legislation was to encourage the trend by creating a new "safe harbor" for like-minded employers from ADP, ACP, and top-heavy compliance, and by extension more general liability. This it did, by preempting any state laws that might be in conflict, and by establishing a new set of safe harbor provisions specific to automatic enrollment.

Employers now have a choice of traditional auto enrollment vs. safe harbor. (I love that it can already be called "traditional.") One key difference is the scope of enrollment - for safe harbor, employers have to enroll all eligible employees, not just new hires. This may be a deterrent, though it's still a good idea: older current employees who aren't participating really need to get with the program. Other distinctions involve contribution rates, and here's where it gets complicated.

Escalators going up
A big innovation in the safe harbor rules is the "escalator" requirement for deferral rates: a minimum of 3% the first year, 4% the next, then 5% and 6%. Compared to many automatic enrollment plans that remain fixed at 2% or 3%, this represents a huge improvement for the participant's financial well-being (as long as the funds aren't automatically invested in underperforming asset classes; see below). It's even better if, as Reish suggests, some seek to avoid payroll complications by just starting everyone at 6%.

Reish feels that even plan sponsors who don't seek compliance with the new safe-harbor provisions are likely to find the escalator attractive. He even speculates that escalating contribution rates may find their way into other plans as well. A new participant could choose escalating contributions instead of a fixed deferral rate at the time they sign up for the plan. It's an interesting idea, and it would seem to have the power of psychology behind it - I expect many reluctant savers would accept a heavier dent in the paycheck sometime in the future to enjoy a lighter one today.

On the other hand, the rules for employer match actually set lower minimums than for regular safe harbor. Perhaps trading higher default contributions for lower employer matches is a regulatory quid pro quo offered to plan sponsors to help get them on board? We might prefer to see both participant and employer contributions max out - I've never heard anyone complain about having too much in their 401(k). But shifting responsibility to the employee is simply the way of things, and when retirement rolls around, what really matters is how much money you've got, not where it came from.

Opting out, staying in
Auto-enrolled employees must be given adequate notice, and have the option to get their contributions back within 90 days. Fair enough. In the meantime, all contributions must be go into a vehicle with a brand-new name, the 404(c)(5) Qualified Default Investment Account (QDIA). Inside that acronym, we find the option of a target-date fund, a risk based fund, or better, an investment management service - what GuidedChoice calls a managed account.

The pros and cons of these options are a topic we've discussed before, as has Reish in another bulletin. The jury's still out on this one, but within a month the DOL is scheduled to clarify exactly what's required for QDIA status, and therefore safe harbor. We'll be watching closely. Along with realistic contribution rates and employer matching, regulations that allow automated, comprehensive investment planning can add the third leg, if you will, of a stable, effective solution to automatic enrollment.

It's somewhat ironic that at a philosophical level we're empowering participants to take on ever more responsibility for their own retirement needs, while at the same time we're trying to automate as many of those decisions as we can. Chalk it up to the gap between human need and human nature, perhaps. Call it prevention of an economic disaster when an under-prepared generation retires. Or just say that it's the right thing to do. Either way, 900 pages of legislation says we really are doing something about it.

~~ Sherrie

He's #1, and for good reason
Fred Reish, ERISA attorney extraordinaire, has been named to 401(k) Wire's Fifty Most Influential list - at the #1 position, no less. Fred's been a friend and supporter of ours for many years, and we're happy to see him receive this honor.

As his firm put it, "We are particularly encouraged that the recognition has come from Fred's positive message that plan sponsors, providers, and advisors should work together to assist employees in their pursuit of benefits that will support a reasonable standard of living in retirement." That goal shouldn't be too much to ask for - and it's why we're in this business in the first place.