VideoAs the fourth element in the autopilot 401(k) process, Brookings nonresident scholar J. Mark Iwry raises the possibility of a default rollover policy that would direct any retirement-savings balance into a new tax-deferred account when the employee leaves a company. (Congress has already provided for this in accounts of $1,000 to $5,000.) As with automatic enrollment, which Iwry sees as the easiest measure for employers to adopt, "if the employee asserts him- or herself, then all those defaults go away. It's just a matter of saying, 'I need the money.'"
By encouraging savings, the automatic approach could help offset an inequity that exists toward lower-income employees. Currently, if a worker's tax bracket is low, so is the aftertax value of his or her savings. "So the system under current law tends to give the smallest benefit to those who need savings the most," says Iwry, former benefits-tax counsel at Treasury who helped develop the autopilot model.
"I call these automatic programs 'empowered paternalism,'" says David L. Wray, president of PSCA, which was also involved in early plan designs. They're necessary because "401(k) plans are not retail investors. And there is a need to think about getting results for employees on the basis of how you design the plan." Critics of current 401(k) designs note that defined-benefit plans, which have been largely replaced by 401(k)s, at least call for automatic enrollment, and provide for management of balances toward some level of compensation replacement.
A Few Notes of Caution
While providers generally enroll participants on a no-fee basis, more enrollees mean higher administrative and recordkeeping costs. Prudential's Sleyster says additional costs from printing more statements and running a larger call center generally would be recovered by plan sponsors combining automatic enrollment with escalation or allocation, thus generating higher returns.
Some companies, though, balk at automatic enrollment because they don't want the widest possible 401(k) participation—especially if their workforce tends to have high turnover among low-income employees, forcing the need to manage many smaller "orphaned accounts" when workers move on. "There can be a good argument made that you're going to be dealing with a larger number of account balances," says Penney's Perez, who says that in his company's case, an automatic enrollment plan is valuable because it helps meet corporate HR objectives. (See "A Benefit at the Top") Nationally, "I think you're going to see momentum" in the use of automatic 401(k) elements, he predicts. "President Bush and Congress are talking a lot about an ownership society. This is one way to advance that."
But for now, Penney has decided not to pursue autopilot steps beyond enrollment. That's because "we'd like to see some more support out there, from Congress and Treasury," Perez says. In March 2004, the Internal Revenue Service wrote an information letter supporting default escalation, to go with its support years earlier for the concept of automatic enrollment.
A final plan-sponsor concern might seem to be the potential for lawsuits filed by employees who didn't want any pay diverted to a retirement savings account. For the most part, "that risk is mitigated because there's ample written notice given," says Iwry. Still, employees have shown an inclination to sue over other perceived wrongs, some of them connected with plans being stacked with their employers' stock. (See "The Cost of Loyalty," December 2004.) To avoid such liability, experts suggest that default investments should be in a balanced fund that mixes fixed-income securities and inflation-indexed bonds with diversified equities.
If that's the case, employees would have little to gripe about. "Because automatic enrollment typically generates employer matching contributions," notes Iwry, "the return is typically higher than anything they would see on their own, even if the investment itself has done poorly."
Roy Harris (royharris@cfo.com) is senior editor of CFO.
A Benefit at the Top
Companies like the way autopilot 401(k) measures help their lower-income employees boost savings for retirement. But there's a nice kick for high-income employees, too.
Under government "nondiscrimination standards," a formula allows companies that increase overall 401(k) participation to proportionally boost the tax-deferred pension contributions of executives and other highly compensated employees even more. For example, says Brookings Institution nonresident scholar J. Mark Iwry, "an increase in the percentage contribution for lower-paid workers from 6 percent to 7 percent might allow the contribution for higher-paid employees to rise from 8 percent to 9 percent."
"I wouldn't say it's the most important reason to adopt an automatic plan," says Scott Sleyster, executive vice president of full-service retirement for Prudential Financial Inc., which has launched a major marketing push for automatic 401(k) measures this year. "But it's a definite side benefit."
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