Plan sponsors warm to automatic features as rule changes await
Automatic features are gaining momentum in the 401(k) arena, according to financial advisers.
Automatic features are gaining momentum in the 401(k) arena, according to financial advisers.
Automatic enrollment in defined contribution plans and automatic escalation of participants’ pretax dollars were given new life by the Pension Protection Act of 2006. The legislation was driven by concerns that employees weren’t saving enough for retirement, and automatic features were meant to be a much-needed solution to this problem.
More plan sponsors are expected to utilize automatic escalation because of the PPA’s safe-harbor provisions, which will go into effect Jan. 1, advisers and industry leaders said. Companies that adopt plans deferring 3% of employees’ compensation automatically and including regular increases do not have to meet “non-discrimination” or “top-heavy” rules meant to prevent plans from favoring its higher earners.
Previously, the Internal Revenue Service had limited the maximum deferral by highly compensated employees to make sure lower-paid employees received at least a minimum benefit in plans where most of the assets were owned by higher-paid, or key, employees. If companies didn’t pass certain tests, they were required to return money to the highly compensated employees.
The safe harbor will allow employers who are currently being restricted by the non-discrimination rules to expand their 401(k) options, said Tom Foster, a national spokesman for retirement plans for The Hartford (Conn.) Financial Services Group Inc. He said companies that failed the non-discrimination tests in the past would be perfect candidates for advisers to approach.
“I take these changes as a marketing opportunity,” Mr. Foster said. “If you’re interested in getting into a 401(k) plan, your role as an adviser is to solve problems. This failed testing is a major problem.”
For John Warmath, a chartered financial analyst who is marketing coordinator at Hardesty Capital Management LLC in Baltimore, differentiating himself in the crowded 401(k) market is a challenge.
“The brokers and advisers who usually have personal contact with the chief executive have as tight of a hold on the 401(k) plan as they do on the chief executive’s personal business,” he said.
TARGET DATE FUNDS
“Advisers have really latched on, and it shows tangible success to their role,” said Kevin Crain, director of institutional retirement group sales and integrated benefits for Merrill Lynch Retirement Group in Pennington, N.J. “It allows them to go to the plan sponsor and say, “I’m a value to your plan.’”
In the past year, New York-based Merrill Lynch & Co. Inc. has seen growth in its automatic features even though the majority of plans still don’t utilize those options.
About 20% of the firm’s 401(k) plans with $5 million in assets or less are using automatic enrollment, Mr. Crain said. That incidence has increased nearly 600% in the last year.
Mr. Crain said that about 15% of plan sponsors with $5 million or more in assets currently use automatic enrollment. A year ago, just 5% of plan sponsors with $5 million or more in assets were using it. Mr. Crain expects that in another year, an additional 15% to 20% of these plan sponsors will be doing so. Of the total plans using automatic enrollment, 30% include automatic escalation, he said. “That number is growing quickly, not at the same rate as automatic enrollment but you’ll see this ramp up,” Mr. Crain said.
Adoption of automatic enrollment — which is the first step toward automatic escalation of contributions — has been somewhat slow, said Stephen P. Utkus, director of The Vanguard Group Inc.’s retirement research center in Malvern, Pa. “There’s a lot of interest, but looking backward, we’re still only dipping our toe into the water,” he said. As of June 1, only 12% of Vanguard’s 401(k) plans offered automatic enrollment.
“I think we’ll see a rising demand over the next few years, but committees don’t hop when Congress passes a bill,” Mr. Utkus said. “They take their time.”
Of all of the clients that have automatic enrollment, 60% of them have automatic-escalation features, he said.
Mr. Utkus believes that once plan sponsors get over their hesitancy to include automatic enrollment, they’re more receptive to automatic escalation. “There’s a change occurring, and clients who have auto-enrolled are now adding auto-escalation,” he said.
Auto-escalation has been thought to help bolster participants’ savings rates even more than automatic enrollment, and a new study showed that automatic escalation can improve participants’ retirement nests.
The Washington-based Employee Benefit Research Institute released an analysis Sept. 12 showing that participants’ plan balances would increase 5% to 28% hypothetically, depending on the person’s income level, if all 401(k) plan sponsors adopted automatic escalation and if the auto escalation started in 2005 and ended when the person turned 65.
Auto-escalation will continue to grow and will help participants save more money, agrees Dave Liebrock, executive vice president at Boston-based Fidelity Investments. “I think it’s a trend that’s moving in the right direction,” he said. “I think it’s growing.”
Fidelity has two versions of automatic escalation. Plan sponsors can include automatic escalation in the plan and allow individual participants to elect whether they want to participate in it or not. Or a plan sponsor can include automatic escalation in a plan and all participants are defaulted into that feature.
Most plan sponsors have been employing plans that allow the participants to choose whether they want automatic escalation of their contributions, Mr. Liebrock said.
In 2006, 7,315 of Fidelity’s plans offered automatic-increase programs, up 19% from 6,136 plans in 2005. But just 21 of those plans offered automatic escalation by default.
Target date funds continue to gain in popularity because they are the prime choice as the qualified-default-investment option in automatic enrollment plans.
Target date assets were at $153 million in July, up from $114 million in December 2006, according to Boston-based Financial Research Corp.
While advisers for the most part like the concept of target date funds, many of them have concerns about the funds because there’s no clear benchmarking or transparency.
“Target date has become very popular,” said Chad Parks, founder and chief executive of The Online 401(k) in San Francisco. The company provides 401(k) services for more than 30,000 participants and 3,000 clients in all 50 states, and has $333 million in assets under administration. “But now there’s this debate about which [target date funds are] better, and what about transparency?” Mr. Parks said.
Advisers continue to have problems with target date funds, said Clark Frese, a certified pension consultant with Asset Strategy Retirement Consultants (formerly Charles River Consultants) in Harrisburg, Pa.
“I don’t like target date funds, personally,” he said.
Lisa Shidler can be reached at [email protected].
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