Ten years after the Pension Protection Act of 2006 (PPA) spurred a huge increase in sponsors performing automatic enrollment, many 401(k) participants still have problematic asset allocations. One big reason: Most companies that started in the past decade have auto-enrolled only new employees, not employees already working at the company.
“So you have decades of employees who have made investment choices along the way, some thoughtfully and some not thoughtfully,” says Anne Lester, portfolio manager and head of retirement solutions for global investment management solutions at J.P. Morgan Asset Management in New York City. “And most participants are not going back and reviewing their original choices.”Story Continued Below
Also, some sponsors performed an auto-enrollment before the Pension Protection Act created qualified default investment alternatives (QDIAs), and many longer-tenured employees remain in the original default. “If a plan previously defaulted employees into something such as a capital-preservation fund, unless the sponsor later went in and did an investment re-enrollment, most of those participants enrolled earlier are still in the capital-preservation fund,” says Toni Brown, senior vice president of American Funds, part of The Capital Group Companies Inc., in San Francisco.
That leaves more-senior employees at an accumulation disadvantage and may delay their retirement—which ultimately costs an employer money. “I always speak up for the ‘legacy’ participants,” says Cynthia Pagliaro, senior research analyst at the Vanguard Center for Retirement Research in Malvern, Pennsylvania. “These people are kind of getting left behind.”
Experience has shown that focusing on investment education alone “does not move the needle enough,” Brown says. “More plan sponsors now are deciding that they will do an investment re-enrollment to get participants to a better retirement, rather than trying to continuously educate them and then rely on them to make their own decisions,” she says.
The vast majority of re-enrollments utilize target-date funds (TDFs) as the default investment, to provide age-appropriate diversification and risk levels, Lester says. “If you have a QDIA you are comfortable using for automatic enrollment, it’s the QDIA you use for re-enrollment,” she says. “Target-date funds are particularly well-suited for these long time periods of investing. If you are going to create an investment for people who are not paying attention to their investments, you need something that will change the allocation over time.”
Some sponsors also utilize re-enrollment to address sub-par savings rates, re-enrolling low-deferring employees at the initial default deferral. Adviser Michele Lantz has a sponsor client currently considering re-enrollment targeted at both investments and deferral rates. After looking at the data, “the consensus is that deferral rates are not where the sponsor would like them to be,” says Lantz, a Palmdale, California-based advisory representative at Pensionmark Financial Group LLC. “So this client, which has more than 1,000 employees, is looking to do re-enrollment every year.”
Further, re-enrollment can help a plan sponsor qualify for the PPA’s safe harbor designation if the sponsor is willing to meet the match level or nonelective contribution level requirements. Adviser James McQuillan talks to employers about how re-enrollment that boosts rank-and-file participation can help testing-challenged plans improve testing results. “These plans are often not safe harbor plans, so testing can be a concern,” says McQuillan, president and founder of RJF Financial Services LLC in Minneapolis.
“As an adviser, I’m helping a plan sponsor understand the natural tension at play here,” he says. “Participants need help [concerning savings rates and investments], and they aren’t getting it. And plan sponsors don’t want to cross into the realm of providing advice. We explain to sponsors why the law provides specific safe harbors for a properly constructed re-enrollment. It gives participants the help they need, while protecting plan sponsors from frivolous lawsuits.”