Wednesday, September 8, 2010

401(K) Auto Enrollment: Who Benefits"

In recent years 401(k) retirement plans, 403(b), and 457 plans) were allowed to adopt auto enrollment of employees.  As of June 30, 2010, approximately 38% of 401(k) plans have adopted auto enrollment; that number is even less if you consider 403(b) and 457 plans.  Large companies have been more likely to adopt auto enrollment than small companies and workers who had not previously saved for retirement increased by approximately 25% in large companies and 9% in small companies.  In that workers who had not been saving towards retirement now are, that is good; however, the default funds into which they must be placed are such that they will not be properly diversified and are unlikely to achieve enough money for a quality retirement during their retirement life time.   It does, however, create captive investors for the plan salespeople.

U.S. Department of Labor regulations are very specific as to what the default choices must be:
"(A) Subject to paragraph (e)(4)(v)(B) of this section, an
investment product or fund designed to preserve principal;
provide a rate of return generally consistent with that
earned on intermediate investment grade bonds; and provide
liquidity for withdrawals by participants and beneficiaries,
including transfers to other investment alternatives. Such
investment product or fund shall, for purposes of this
paragraph (e)(4)(v), meet the following requirements:
    (1) There are no fees or surrender charges imposed in
connection with withdrawals initiated by a participant or
beneficiary; and
    (2) Such investment product or fund invests primarily
in investment products that are backed by State or federally
regulated financial institutions."
These are usually a money market or stable value fund, a lifecycle or target date fund, a balanced fund, or a managed account such as a variable annuity.  Target date and lifecycle funds are under SEC scrutiny, because the same date funds from different companies are not similarly invested and disclosure to investors is less than desirable.  Stable value funds may have contractual problems that make them unacceptable or problematic in a qualified plan.  Money market funds are currently very low interest and have no principal guarantee like a money market at a bank.  A variable annuity can have internal costs and may or may not guarantee (for additional costs) principal or provide a lifetime income (however small).

The employee is sent an auto enrollment notice which specifically informs the employee they have the right to opt out, to actively choose their own investments within the retirement plan, or accept the default investment fund or funds which are specifically named in the notice.  The employee knows exactly in what funds the retirement contributions are invested.  The employer makes no choices for the employee; the plan administrator has chosen a default fund or funds meeting the regulations of the Department of Labor.  The employee may elect at a future date to change the investments within the plan or opt out.

Many employees do not want to make choices, lack investment knowledge, or face the choices of retirement and they ignore the notice.  The plan administrator's duty is to the company and cannot give fiduciary advice to participants.  Some companies make investment advice available, but it is from advisers who have conflicts of interest, although there are proposed regulations which would require participant advisers to be conflict free fiduciary advisers. Participants need impartial, conflict free, professional advice, but it is still very much a sales person's game.  The same employees who pay no attention to their auto enrollment notices and options also have no idea who is a fee only fiduciary advisor with no conflicts of interest as opposed to those who are not fiduciary duty bound and have conflicts of interest but can still legally call themselves fee only advisers, because the SEC makes it very difficult for even a knowledgeable investor to ferret out the distinctions.

Employees need to take responsibility for their retirement investments and seek out an affordable fee only, fiduciary duty to the client only, impartial professional advisor.  This requires they take action and ask questions.  How many do that?  How many employers provide conflict free help?  Not very many.

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