Congress seeks to address employers' concerns on automatic enrollment

01:00 PM EDT on Monday, May 29, 2006

By PAMELA YIP / The Dallas Morning News

One of the biggest issues that employers and financial advisers have struggled with is convincing more workers to participate in 401(k) plans.

Joyce Hesselberth / DMN

Nearly half of employees examined in a study by consulting firm Hewitt Associates weren't enrolled in their company's 401(k) plan or failed to contribute enough to obtain the full company match.

That's leaving free money on the table.

Many personal finance experts say the best way to get workers enrolled in 401(k) plans is to automatically do it for them.

As it weighs a revamp of the nation's pension laws, Congress is hoping to encourage more employers to offer automatic enrollment in 401(k) plans.

While some companies have automatic enrollment programs, others are reluctant to offer them.

A major concern is running up against state laws prohibiting wage garnishment. Texas is one of the states that bars wage garnishment.

"Wage garnishment is huge," said David Wray, president of the Profit Sharing/401(k) Council of America, which represents employers. "It's the number one thing holding it back. Employers are afraid of running up against wage garnishment laws, which require you to get written permission before taking money out of someone's paycheck," except for certain permissible things like income-tax withholding.

Companies want the law to be clearer on this, he said.

"Many employers don't like the fuzziness of this," Mr. Wray said. "They want it specifically spelled out in federal statute."

Congress is attempting to do just that with legislation that would pre-empt state laws against wage garnishments when it comes to automatic enrollment programs for 401(k)s.

Another concern of employers is the legal liability associated with determining how their employees' retirement money is invested.

"If the employer is automatically enrolling people," said Mr. Wray, "most of them [employees] are not going to go in and give you some direction on the allocation, so the company is going to have to make the decision and be responsible on how this money is going to be invested."

To assuage employers, Congress is including language in its pension legislation that would give companies protection from liability under these circumstances.

Bill would ease 401(k) rules for companies

With more companies abandoning traditional pension programs, Congress is looking for ways to help individuals build their own retirement nest eggs.

A key part of Congress' efforts is encouraging more employers to offer automatic enrollment in 401(k) plans.

"The basic idea is that as defined-benefit plans wind down and the 401(k) plan becomes more important, the legislators are trying to figure out, how do we change 401(k) plans so that more people end up with more money?" said Jeff Maggioncalda, chief executive of Financial Engines Inc., an investment advisory firm.

In 1995, no companies were offering automatic 401(k) enrollment, according to Hewitt Associates, a human resources consulting firm.

By 1997, 4 percent of 401(k) plans were using automatic enrollment, and last year, 19 percent of 401(k) plans automatically enrolled workers.

Congress wants to encourage more employers to use automatic enrollment in their 401(k) plans by inserting provisions in pending pension legislation that would address companies' concerns about liability for using automatic enrollment.

The Labor Department is also doing its part.

"We've been taking a look at the issue and seeing what we can do to remove barriers to employers' willingness to adopt automatic enrollment programs," said Ann L. Combs, assistant secretary of the department's Employee Benefits Security Administration.

For example, companies currently are required each year to conduct so-called nondiscrimination testing on their defined-contribution plans, such as 401(k)s, to ensure that the plans don't favor highly compensated employees over lower-paid workers.

Under the proposed legislation, "as long as the 401(k) plan met certain design features, they wouldn't have to go through annual testing," Ms. Combs said.

Program's conditions

Companies would be deemed to have met nondiscrimination rules and requirements for vesting and matching contributions if their automatic enrollment programs provide for the following:

• Employee contributions equal to 3 percent of pay in the first year, increasing annually by 1 percentage point until reaching 6 percent of pay, up to a maximum of 10 percent.

• Employer matching contributions of at least 50 percent. Alternately, employers may contribute 2 percent of pay on behalf of all employees, regardless of whether employee contributions are made.

• Employer contributions must fully vest after two years.

Some companies are uncomfortable with automatically increasing an employee's 401(k) contribution over time, Mr. Maggioncalda said.

"Most employers fear that someone calls and says, 'I don't want this,' and the worst-case scenario — they try and sue them," he said. "The much more practical concern is, they just don't want the headache of people calling and saying, 'Why are you taking an increasing amount of my paycheck?' "

Employers also fear that if an employee decides to opt out of the automatic 401(k) program, he may want the company to pay the 10 percent early-withdrawal penalty, "because the employer decided to put the employee in the 401(k) in the first place," Mr. Maggioncalda said.

But he said the bill addresses that concern by offering "an unwind period" so employees have a certain number of days in which to cash out without paying a penalty.

Employer concerns

The pension legislation also directs the Labor Department to develop a "safe harbor" to give employers legal protection for the sound investment of pension assets for workers who don't direct investment of their 401(k) contributions.

Ms. Combs said employers have consistently expressed concern about "their fiduciary liability for the investment of the assets" when they don't have explicit directions from the employee on how the money is to be invested.

The "safe harbor" under consideration would shelter employers if they invested employees' money in a fund with a mix of stocks and bonds, or a life-cycle fund that changes to a more conservative blend of stocks and bonds as the employee gets closer to retirement.

If a company followed that guideline, "then the employer would not be responsible for the investment performance," Ms. Combs said.

This could also benefit individual workers.

In the absence of firm guidelines, companies with automatic 401(k) enrollment programs have tended to invest their workers' money in conservative vehicles — such as money-market mutual funds — that don't provide the long-term, inflation-beating growth that's needed for retirement.

Another possible default investment choice may be a managed account where a professional, such as Financial Engines, manages the 401(k) account.

The legislation also would pre-empt state laws against wage garnishments when applied to automatic 401(k) programs. Employers fear those laws would prevent them from automatically taking money out of employees' paychecks to contribute to their 401(k)s.

While all those efforts may lead more employers to offer automatic enrollment in 401(k) plans, employees must remember one thing: Although much is being done for you in those plans, you must still remain engaged in the process.

Managing your portfolio

"Rebalance the portfolio on a regular basis," said Ivory Johnson, director of financial planning at the Scarborough Group Inc., an investment advisory firm specializing in 401(k) management and retirement planning services.

"You also want to make sure that you're diversified. They may have a default, and it may be cash or it may be employer stock, both of which are probably not the best investments for retirement," he said.

Added Mr. Maggioncalda of Financial Engines: "If your money is going into the most conservative option, you've got to change it. Don't let it sit in the most conservative option because it won't grow fast enough to pass inflation."

At the same time, don't bet too heavily on company stock. No more than 20 percent of your money should be in company stock, Mr. Maggioncalda said.

Make sure you're saving enough. This year, the maximum contribution limit for 401(k) plans increases to $15,000. Workers 50 years or older are also eligible to make an extra $5,000 catch-up contribution to the plan.

"Just because it's automatic enrollment, it's probably not maxing you out," Mr. Johnson said. "You need to start determining, am I saving enough for retirement?"

Save at least enough so you get company matches to your contributions. If your company doesn't match your contributions, save as much as you can.

Finally, don't opt out of the 401(k) plan.

"Stay in the plan unless you simply can't afford to pay your rent and put food on the table," Mr. Maggioncalda said. "People will get tax-free growth for years and years."