The Pension Protection Act, passed in 2006, gave a major boost to automatic enrollment 401(k) plans. These plans enable companies to include employees in their plans unless they choose to opt out of participation. Now, new proposed regulations provide guidance for default investments. Auto-enrollment plans were available before the law passed. But the Pension Protection Act overcomes certain state law hurdles that hindered these plans in the past. Employers can limit the automatic feature to new-hires or extend it to the existing workforce. To further encourage retirement savings, the new law makes it easier for employers to automatically increase the percentage of an employee’s salary directed to the account.
“Too many workers, some overwhelmed by investment choices or paperwork, are leaving retirement money on the table by not signing up for their employers’ defined contribution plan,” said Former U.S. Labor Secretary Elaine L. Chao. “This regulation would boost retirement savings by establishing default investments for these workers that are appropriate for long-term savings.”
One likely side effect of installing an auto-enrollment plan is larger allowable salary reduction contributions for higher-paid employees, because lower-paid workers are contributing more.
Prior to the Pension Protection Act, plan sponsors were often reluctant to assume the responsibility for making investment decisions without specific direction from participants. Thus, the sponsors typically sought to minimize exposure by limiting default investments to money market funds and other conservative vehicles.But once a company decides on an automatic enrollment plan, the question is: Where to invest the money?
Now plan sponsors have more options. Under the new Labor Department regulations, a participant is treated as exercising sufficient control over the account assets if these six basic requirements are met:
- Assets invested on behalf of participants are allocated to “qualified default investment alternatives.”
- Participants have the opportunity to direct investment of the assets in their accounts (but not direct the assets).
- Participants must receive adequate notice.
- Materials provided to the plan about investments are made available to participants.
- Participants have sufficient time to transfer assets.
- The 401(k) plan must offer a range of investment alternatives.
Default investments should be diversified to minimize the risk of large losses. In addition, if a participant chooses not to direct the investment of assets in his or her account, age is the only objective and readily available factor for making an investment decision on his or her behalf. Other factors — including risk tolerance and total investment assets — do not have to be taken into account.
In summary: The Pension Protection Act can result in key changes for your company’s plan. According to the Labor Department, approximately one-third of eligible workers do not participate in their employer-sponsored 401(k) plans. With the new regulations, your company can increase participation dramatically. Consult with your tax adviser and benefits professional to find out how to take advantage of the new law and to help ensure compliance.