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401(k) Plans Undergoing Facelift

The 401(k) plan is undergoing a facelift. Twenty-five years after the Internal Revenue Service gave provisional approval to the first such retirement savings plan, financial services firms are introducing a slew of new features that, for many American workers, will make the 401(k) function a bit more like a traditional defined benefit pension plan. Among the changes: automatic enrollment strategies that extend the reach of the plans to more eligible workers, greater access to professional investment advice, and greater access to professional money managers for their plan assets. One thing that isn’t changing, of course, is that participants, not their employers, will still bear primary responsibility for funding their 401(k) accounts. And they will retain the authority to direct their 401(k) investments themselves if they wish.

The newly passed Pension Protection Act of 2006, by creating fiduciary safe harbors under which plan sponsors can set up automatic enrollment programs and provide investment advice to plan participants, will hurry these changes along. Unfortunately, says attorney Randy Hardock, a partner with the law firm of Davis & Harman LLP in Washington, D.C., some of the plan sponsors will need clarification from federal agencies to take full advantage of the new law’s key features may be slow in coming.

Blame politics. The new law capped a tortuous legislative process that had lawmakers fiercely at odds with each other. “This bill had more people fighting in the legislative and executive branches than I’d ever seen,” Hardock told attendees at the SVIA’s annual national forum in Washington, D.C., in October. “You had the White House fighting with Congressional Republicans, Republican committee chairmen fighting with the Republican leadership in the House and Senate, and committees fighting with committees.” The result, he says, is that many of the players in Congress aren’t in the mood to come back to the table and reopen old wounds, preferring to let the regulatory agencies, such as the Department of Labor (DOL), Treasury, and, to a lesser extent, the Pension Benefit Guaranty Corporation, figure out how to fill in the details. Unfortunately, Hardock warned, those agencies are undergoing a personnel shakeup—the DOL’s Ann Combs, assistant secretary of the Employee Benefits Administration, is stepping down from her post, for example—meaning that guidance could come “in dribs and drabs.”

One area where the DOL is acting fast, however, is on the question of what constitutes an acceptable default investment option for a defined contribution plan. In September, the Department issued proposed guidelines that would provide a fiduciary safe harbor for plan sponsors—assuming six conditions of implementation are met—who default their participants into three types of investments: lifecycle or “targeted-retirement-date” funds, balanced funds, or professionally managed accounts. The DOL is soliciting comments on the proposed rules and is expected to have the new regulations finalized in the first quarter of 2007.

While plan sponsors could continue to use other types of investments as default investment options under the new regulations, they wouldn’t enjoy the same fiduciary safe harbor given to other plan sponsors. In practice, Hardock predicts, most sponsors will migrate to those that have been blessed by the DOL. Hardock also predicts that growing numbers of plan sponsors will adopt an automatic enrollment policy for their defined contribution plans.

In other areas, Hardock said he doesn’t expect plan sponsors to stop using employer stock as an investment option in their plans. And he suspects that many sponsors who have not yet begun to make investment advice available to their plan participants will continue to hold off on that until the new law’s language on that subject is clarified. The law is fuzzy, for example, in its description of the circumstances under which a financial advisor can give individualized advice to plan participants beyond that generated by a computer model. It also isn’t terribly clear how audits of advice providers should be conducted.

Hardock also predicted that the traditional defined benefit pension plan is not going to become extinct anytime soon. “More defined benefit plan freezes are almost a certainty,” he said, “but these things go in cycles. I think we will see to some extent a revitalization of defined benefit plans, perhaps in the form of hybrid plans. These types of plans offer advantages for many companies, especially in the small plan market.”

Finally, Hardock predicted that however the November mid-term elections turn out, Congress is likely to turn its attention back to pension legislation again soon, despite having just passed the PPA. The emphasis on the next go around, he said, is likely to center on expanding the defined contribution plan system and expanding private savings in general. One issue legislators might address, he said, is the establishment of automatic distribution requirements for participants leaving defined contribution plans.

That, too, could have the makings of a good political battle.

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