See this year's 401(k) Special Report.

The credit crunch has come home to roost in many unlikely places, from the student-loan market to the municipal-bond arena. Here's another improbable victim: your human resources department. The subprime crisis and its many ripple effects are prompting more financially strapped homeowners to borrow from their 401(k) plans. That not only puts their long-term fiscal health in jeopardy, but also places a large burden on their employers.

"Loan programs may be the single most disliked and burdensome administrative difficulty associated with operating 401(k)s," says employee-benefits attorney Fred Reish of Reish Luftman Reicher & Cohen in Los Angeles. Too often, he says, discrepancies between the amortization schedule created for the loan and the repayment schedule created by a company's payroll vendor go undetected until a retirement plan is audited by the Internal Revenue Service, whereupon the employer must scramble to set things right. "It's a nightmare," agrees consultant Kendall Storch, director of retirement services with Boston-based Longfellow Benefits. "The tracking of the loans, the managing of the repayments, the fallout if for some reason the payments get off schedule — it all becomes a big hassle."

It's no picnic for employees, either; they face a raft of difficult calculations when deciding whether to tap a 401(k), and often don't understand the potential long-term (or even short-term) impact of such a move.

Emergency Room
Plan sponsors aren't required to offer loan programs, but a majority do. Companies routinely add a loan feature to their 401(k) plans in the belief that more employees will participate if they know they can access the funds in an emergency. But many experts say that view is misguided, and some finance chiefs agree. David Magers, executive vice president and CFO of Country Insurance & Financial Services, a privately held insurance, banking, and asset-management company, says he thinks "the defining reason employees don't sign up is cash flow. They're having trouble paying the rent."

Nonetheless, Bloomington, Illinois-based Country offers 401(k) loans because, as Magers says, "we realize there are going to be occasions when not allowing employees access to that money could put them in a position of hardship. There are times when they may need to borrow."

Hard Times
Like now, for instance. Major 401(k) providers report 13 to 19 percent jumps in loans and hardship withdrawals, with the fourth quarter of 2007 seeing a major spike in such activity. The appeal for employees is understandable, at least on the surface: you pay interest to yourself. In fact, in the first few years of this decade, when the stock market and money-market funds on average were earning 1 percent or less, an employee repaying a loan at, say, 7 percent (a typical rate is 1 percent over prime) actually earned a better rate of return than he or she might have under most other scenarios.

But far more often loans work against employees, in a number of ways. "If employees are busy paying back their loans, they can rarely also continue to contribute at their previous level," warns Jeanne Brutman, an independent financial adviser in Jackson Heights, New York. "This greatly impacts the future value of their account, as the missed contributions are not compounding over time."

Even more risky, as Richard Reyes, owner and founder of Wealth & Business Planning Group LLC in Maitland, Florida, points out, is the chance that employees won't be able to pay back their loans. When that happens, a loan becomes, in IRS lingo, a "deemed withdrawal," subject not only to ordinary income-tax rates but also, if the participant is under the age of 59 1/2, a 10 percent penalty tax.

Defaults are especially common when participants quit or lose their jobs, since 401(k) loans then become due in full — just when participants are least likely to be able to pay them back. While this termination provision is routinely spelled out in the plan's summary plan description and other documents — protecting employers from claims that it wasn't disclosed — it often catches plan participants by surprise.

Reyes recalls one highly compensated client who took out a $50,000 loan from his 401(k) plan just before unexpectedly losing his job. "He had no way to pay back the loan, so he had to pay income taxes on it at the highest marginal rate, plus a 10 percent penalty because he was under the age of 59 1/2," Reyes recalls. "He didn't have the money to pay that tax bill either, so he had to take even more money out of his IRA, and this created a snowball effect. He lost everything."

Russ MacMannis, vice president of finance for $200 million Barker Steel, in Milford, Massachusetts, says about 25 percent of the participants in his company's 401(k) plan have loans outstanding at any given time. Some are clearly struggling. "We see cases where people reduce or suspend their regular deferrals just to pay back their loans," he adds. "And we have a small group of people who never see a full paycheck except during the three-month waiting period we require between loans."

Indeed, many employers enforce a waiting period between the repayment of a loan and the resumption of regular contributions into an account, which is yet one more way that taking a loan can diminish an employee's long-term savings. Some don't allow for the simultaneous repayment of a loan and continuing contributions into an account. And, of course, employees will miss out on any employer matching contributions during periods in which they are repaying loans but not putting any "new" money into their accounts.

All of this comes at a time when 401(k) plans face an additional form of peril: stagnation. According to Deloitte, after years of strong growth, participation in 401(k)s appears to be "topping out." For example, in 2000 there were approximately 687,000 defined-contribution plans in the United States. By 2004 that number had actually dropped by about 50,000. Meanwhile, 52.9 million employees participated in such plans in 2002, a number that dropped by 700,000 participants two years later. Add to that anecdotal evidence that many workers lack the financial literacy to understand simple concepts like the effects of compound interest (in a recent Journal of Monetary Economics article it was noted that only 18 percent of adults could answer a simple question regarding how much $200 in a savings account would be worth two years later if the account paid 10 percent per year), and it seems that 401(k) account management is something many workers struggle with.

What to Do
Given all that, it's not surprising that Reish advises employers not to offer loan programs unless they truly deem it necessary to get employees to participate in their 401(k) plans. Employers who do offer loans can take measures to minimize both the administrative pain that such programs generate and the potential for abuse by employees.

• First, limit participants to one loan at a time. "We used to allow two loans, and it was just exponentially more difficult to administer," observes MacMannis. "You have to keep track of which payment is for which loan. We also found that it was really being abused by employees."

• Next, require that participants wait some period of time after paying off a loan — say, six months — before allowing them to take out another one. Otherwise, loans can become a permanent crutch. "We absolutely have clients where people use the loan program like a revolving door," says Storch. "It defeats the whole purpose of having a retirement savings plan."

• In extreme cases, employers can allow loans only for the same limited reasons the IRS allows hardship withdrawals from 401(k) accounts, such as to pay for un-reimbursed medical expenses or to prevent the loss of a home (see "Hardship Withdrawals" at the end of this article). And, even though employees are paying interest to themselves, setting the rates higher may prompt some to explore the options at their local bank or credit union.

Finally, employers can do more to educate employees about the potential hazards of taking money out of their retirement plans, from the tax bite to the payback provisions to the long-term impact it can have on the size of their retirement nest egg (see "The Price You Pay" at the end of this article). Companies devote plenty of time and energy to encouraging employees to join 401(k) plans; they would do well to devote just as much to explaining why it's important to stay in, and why loans so often amount to getting out.

Randy Myers is a contributing editor of CFO.

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Hardship Withdrawals

Loans are one way that participants in 401(k) plans can take money from their retirement accounts before retiring. The other is through a hardship withdrawal. Unlike loans, hardship withdrawals need not be paid back. However, they can have onerous tax consequences. Except in very limited circumstances, they are taxed at ordinary income rates, and, if the participant is under the age of 59 1/2, they also carry a 10 percent penalty tax. The Internal Revenue Service allows hardship withdrawals only for very specific reasons: to cover un-reimbursed medical expenses, to purchase or repair a primary residence, to avoid eviction from or foreclosure on an existing residence, to pay for tuition or related educational costs, or to pay for a funeral.

Employers aren't required to offer hardship withdrawals, but most do. Country Insurance & Financial Services has managed to keep them to a minimum, however, in part by requiring that before participants take a withdrawal they first exhaust their loan limits, which the IRS sets at 50 percent of an account balance up to a maximum of $50,000. While its 401(k) plan has approximately 4,300 participants, Country processes only about five hardship withdrawals per year, says CFO David Magers. By contrast, about 600 participants have loans outstanding at any one time. — R.M.

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The Price You Pay Employees who borrow from their 401(k) plans can pay a big price if the cost of repaying such loans prevents them from continuing to make regular contributions to their plans. Matt Riebel, president of Nationwide Retirement Solutions, a unit of Nationwide Financial Services, offers this example of a 35-year-old with a current account balance of $30,000 who takes out a 5-year, $8,200 loan:
	Continues making $2,000 annual deferrals during loan-repayment period	Discontinues $2,000 annual deferrals during loan-repayment period
Account value at age 35	$30,000	$30,000
Annual deferrals during loan-repayment years	$2,000	$0
Annual deferrals after loan-repayment years	$2,000	$2,000
Annual ROI	7%	7%
Account value at age 65	$417,289	$354,866
	Difference: $62,423 (15%)
Source: Nationwide Retirement Solutions

See this year's 401(k) Buyer's Guide.

Last summer, when a federal judge dismissed a suit brought by employees of John Deere & Co. alleging that they were charged unreasonable and poorly disclosed fees in their 401(k) plans, companies may have been tempted to breathe a sigh of relief. A number of such suits have been brought over the past two years, making companies acutely aware of a fiduciary responsibility that few seem suitably prepared to address.

Turns out that relief was short-lived. In March, the Department of Labor (DoL) lent its weight to the employees' side of the case, filing a brief in support of their claim as they pursue an appeal. It's the latest salvo in the battle over 401(k) fees, namely how to accurately assess and communicate them to employees.

Over the years, as more providers have gotten into the defined-contribution business, their fees and behind-the-scenes revenue-sharing arrangements have become so complex that plan-expense comparisons are virtually unattainable. And that's a problem. If plan sponsors can't ascertain the true cost of their defined-contribution plans, they certainly can't explain fees to plan participants, who pick up many of these expenses. The upshot has been litigation against more than a dozen plan sponsors and intense scrutiny of 401(k) fees by Congress and the DoL. The latter is in the midst of receiving public comment on proposed guidelines to make fees more reasonable and transparent.

Rather than wait for the DoL to issue new regulations, some companies have called in retirement advisory firms to analyze and benchmark the hodgepodge of fees that they and their employees pay for the services rendered by 401(k) providers.

Doubts about the suitability of fees affect a wide swath of plan sponsors. According to a study released in March by Chatham Partners, while 79 percent of plan sponsors believe understanding their 401(k) plans' overall costs is important, only 58 percent feel confident they do. Thirty-four percent said they found it difficult to compare one plan's fees with another's, and only 38 percent say their provider discloses its revenue-sharing arrangements with partner firms.

Were these respondents able to obtain full disclosure of what they're really paying for — many providers give out only a bottom-line number — they would find wide disparity. According to data compiled by HR Investment Consultants, for a plan covering 500 participants with average account balances of $50,000, the shared fees paid by plan sponsors and participants ranged from $211 to $822. "Given today's legal climate, employers should be wary if they are paying more than the average cost [$599]," says Joe Valletta, a principal and co-author of the investment advisory firm's 401(k) Averages Book.

Wariness, indeed, makes sense given the lineup of companies alleged to be in violation of the Employee Retirement Income Security Act of 1974 (ERISA). Companies ranging from Boeing to RadioShack are embroiled in litigation filed by employees over the reasonableness and disclosure of the 401(k)-related fees they have paid.

None of the cases have been settled, although a lawsuit filed by employees of Deere & Co. against Fidelity Investments, the company's trustee and record-keeper for its $2.5 billion 401(k) plan, was dismissed last July. (However, as of March, the DoL has become involved and is asking the judges to reconsider.) Nevertheless, increased due diligence seems in order, given sponsors' fiduciary obligations to protect the interests of employees. "If a sponsor doesn't know how the bundled fees are broken down into different buckets, it cannot compare them with the fees charged by other providers," says Pamela Hess, director of retirement research at Hewitt Associates. "Yet sponsors have a legal obligation to make sure their contracts are reasonable."

Nobody's Business
When defined-contribution plans came on the scene in 1978, after Congress amended an Internal Revenue Code to permit them, plan fees were easy to interpret. That's because the original providers were third-party administrators (TPAs), such as Hewitt or Mercer, that charged a single fee to employers for the administrative services associated with the three or four investment options presented. On top of that, the plan sponsor might pay an investment manager to handle the portfolio. "It was pretty basic when defined-contribution plans were new and few," says Leslie V. Smith, senior vice president of Aon Consulting's retirement practice. "When 401(k) plans took off they also became extremely convoluted from an expense standpoint."

Once the mutual-fund companies realized they had the technology in place to handle the record-keeping themselves, they gave the TPAs stiff competition. The companies offered "free" record-keeping — the administrative services that sponsors paid for.

The major drawback for plan participants was that investment options were limited to the mutual-fund company's proprietary products. Realizing this, the TPAs brokered a truce with the fund companies. The TPAs offered to include the companies' funds in the menu of investments they provided, linking the parties' technology so participants could execute trades. They also provided record-keeping and other administrative services, which would still be "free" to sponsors. In the background, the partners would share revenue. "They essentially joined hands," Smith says.

TPAs now had leverage over the mutual-fund companies because they could offer an array of mutual-fund families — say, a T. Rowe Price large-cap fund here, a Vanguard international equity fund there. The mutual-fund companies became lesser players, a situation they remedied by creating revenue-sharing arrangements with one another, opening up their technological architecture to permit trades out of one fund family into another, while providing their own recordkeeping services or hiring the TPAs to do it for them.

This had the good effect of permitting plan participants to significantly diversify assets across several funds and fund classes. On the down side, all the complicated side deals obscure actual plan costs. Not that the bundled fee isn't listed in the prospectus — it is. But the components of this fee (administrative expenses; trustee, audit, and legal costs; consulting expenses; statement fees; trading costs; potential performance bonuses; and the actual fund or investment fees) are unclear. "The difficulty is in peeling back the onion," says HR Investment's Valletta.

Moreover, under current ERISA law, the behind-the-scenes revenue sharing is essentially nobody's business, explains Robyn Credico, national director of defined-contribution consulting at Watson Wyatt Worldwide. "If all the fees are paid through revenue-sharing arrangements," she says, "technically you don't have to disclose anything." The Labor Department is looking to change the law by making revenue-sharing arrangements completely transparent.

The point is to find the best deal, not necessarily the lowest cost. "Plan sponsors have to understand what they're getting to make an informed decision — the lowest fee is not always the best value," says Jim Morris, senior vice president of institutional solutions at SEI Investments.

Shooting Blind
Sounds easy enough, but many plan sponsors are ill-equipped to peel the onion. In such cases, retaining an advisory firm like Resources for Retirement, Aon Consulting, or Watson Wyatt to pare fees down to their essentials offers recourse. Morris has another solution. "Demand to know what you're paying and how that compares with what others are charging," he says. "Many providers have already had themselves benchmarked and will hand over the results if requested."

Such was the case for RLI Corp. "Our recordkeeper, Principal Financial Group, itemized every source of revenue it would earn from our 401(k) plan and ESOP: management fees for its mutual funds, service fees it earned on outside mutual funds, and direct payments from our company," says Jeff Fick, vice president of human resources at the Peoria-based specialty-lines property-and-casualty insurance company. "We then compared those total fees with the services it would provide to our employees. Principal provided us with complete disclosure, which then helped us negotiate the best deal." Some companies feel more confident in turning to an outside party for such analysis.

Southwest Power Pool Inc. hired an outside firm to objectively examine all facets of its 401(k) plan. "It was just too much for us internally," says CFO Tom Dunn. "They did the spadework and were able to give us the net return on each fund after the fees were extracted. As a fiduciary, if you don't have the skill sets, you're just taking a shot in the dark."

And in these litigious times, a blind shot might ricochet.

Russ Banham is a contributing editor to CFO.

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Mark Anderson is in the middle of overhauling his company's 401(k) plan. Anderson is the finance chief of Granite City Electric Supply Co., a Quincy, Massachusetts-based distributor with about 180 employees. The project began because he and the company's investment committee wanted better service from Granite City's 401(k) provider. But as they started reviewing the plan, Anderson realized there was another reason to change. "We offer something like 25 or 35 funds," he says. "It's excessive. People get overwhelmed."

Gone are the days when designing a 401(k) plan meant little more than offering every kind of fund under the sun and letting employees choose among them. Today, companies realize that the investment behavior of many 401(k) participants ranges from the discouraging to the downright frightening. Moreover, research has shown that offering a slew of options can actually stymie employee choice and hinder plan participation.

As a result, more and more companies are taking their plans back to the drawing board. The task is becoming increasingly urgent, as the oldest members of the baby-boom generation approach retirement armed mostly with 401(k) savings. Companies like Granite City are redesigning their plans with an eye to providing a more manageable and appropriate menu of investment options. They are striving to make their plans as balanced as possible, adding healthy new choices such as lifecycle funds and collective trusts. And they are monitoring their plans to make sure that funds don't drift from their stated goals.

There is also another reason for CFOs to revisit the mix of fund choices and structure of their 401(k) offerings: the Department of Labor has just released its final ruling on the types of investments deemed appropriate for automatic enrollment. Money-market and other stable-value funds, which many companies offer as a default option for employees, didn't make the cut. The three types that did: lifecycle funds, balanced funds, and professionally managed accounts. (The DoL approved capital-preservation products as qualified default options for only the first 120 days of plan participation.)

Age Appropriate
Given the DoL's blessing, lifecycle funds should become markedly more popular. Also called target-maturity or target-date funds, lifecycle funds first appeared in 1995 but have just begun to catch on in the last five years. Still, just 33 percent of employers currently offer them in their 401(k) plans, according to the Profit Sharing/401(k) Council of America.

Like balanced funds, lifecycle funds comprise a balance of stocks and bonds. Unlike balanced funds, they are managed to automatically shift their investment mix to an appropriate level of risk as the employee ages. Their names — such as "Vanguard Target Retirement 2020 Fund" or "Putnam Retire Ready 2045" — usually feature retirement dates, making it easy for employees to choose the right fund. While some criticize the funds as too conservative or not diversified enough, they should provide better growth over the long term than stable-value vehicles.

"If you are on the hook as the fiduciary, you're thinking, 'Let's get folks into an investment structure that is appropriate for their age and their time horizon,'" says Sue Walton, senior investment consultant at Watson Wyatt Worldwide. "[Lifecycle] funds are appropriate and consistent." Forty-five percent of employees invest in lifecycle funds when they're available, according to data from Hewitt Associates.

Some lifecycle funds used to charge up to 0.75 percent of plan assets to manage asset allocation for employees, but fees have come down significantly as competition has intensified. Now, some companies don't add a fee for asset allocation at all, and those that do generally charge around 0.5 percent of plan assets for active management. Many lifecycle-fund managers now offer lower-cost alternatives for institutions like 401(k)s, and some are offering low-cost index-based options whose management fees are closer to 0.2 percent of plan assets. When comparing lifecycle funds, plan sponsors should look at the total package of fees — both those for the underlying funds and any additional management fee, says David Wray, president of the Profit Sharing/401(k) Council of America.

Large employers can reduce fees further by creating their own customized lifecycle options based on the funds in their plans, rather than simply offering prepackaged funds from a provider like Fidelity or Vanguard. "If you've done your job as a plan sponsor, the fees on the funds in your plan are pretty inexpensive, and they should be good investment options," says Grant Verhaeghe, investment consultant at Aon Consulting. "You can create a fund that is better than one that simply invests in a proprietary family of funds."

Anderson says the move to lifecycle funds is the biggest change that Granite City is making to its plan. "[Employees will] get some growth over a long time horizon, and [their investments] won't be just sitting in a money-market fund earning the bare minimum rate," says the CFO. Granite City is making lifecycle funds the default option for its plan.

For companies that do offer lifecycle funds, investor education is essential. While some plan participants like to allocate some of their investment dollars to such a fund and spread the rest around, the blended nature of a lifecycle fund may cause the employee to end up overexposed to certain parts of the market. Employers should therefore encourage participants to either put all of their 401(k) dollars into a lifecycle fund or avoid the category entirely, say experts. "They should be an all-or-nothing proposition," says Verhaeghe.

Some employees also choose multiple lifecycle funds — for example, a 2020 fund, a 2030 fund, and a 2040 fund — in the mistaken belief that doing so is similar to choosing a mix of stock and bond funds and will thus yield better diversification. "That's a good sign there needs to be some education," says Verhaeghe. Employers can also structure their plans so that employees may choose only one lifecycle fund.

Extra Choices
For more-sophisticated investors who want to make their own fund choices, employers should offer a selection of active and passive funds that span the risk-return spectrum. With a couple of index funds, domestic and international equity funds, a fixed-income option, and a stable-value or capital-preservation fund, employers can cover the critical bases required for diversification.

Yet, while experts have long recommended paring back 401(k) offerings to just 10 or 12 fund choices — and although studies have shown that employees often find a wide array of choices so daunting that they opt to do nothing — the average number of funds offered by companies remains too high at 18, according to the Profit Sharing/401(k) Council. "It's hard to take things away, and anything you take off the investment menu is viewed as a takeaway by participants," comments Walton. "Even plan sponsors still have the perception that more is better, even though data shows that having too many options leads to poor participation."

Depending on the demographics of the employee base, employers may decide to add a few (and just a few) specialized choices to their core offerings. For example, at Method, a maker of eco-friendly cleaning products, employees were polled about what they wanted in a 401(k) when the company established its plan last year. Perhaps not surprising, "the loudest response was from people who were looking for a socially responsible choice," says CFO Andrea Freedman. The company now offers a socially responsible fund as well as index funds, which employees also requested. Method offers about 15 funds in all.

At Aruba Networks, a Silicon Valley, California-based technology firm with a fairly investment-savvy employee base, finance chief Steffan Tomlinson says staffers clamored for more choice. As a result, Aruba's plan has some 15 to 20 funds, including a series of lifecycle funds and an international bond fund.

But companies shouldn't offer too many eclectic or trendy choices, because they often fail to perform well in 401(k) plans, which can have time horizons of as long as 40 years. Pamela Hess, director of retirement research at Hewitt Associates, cites real estate investment trust (REIT) funds as a specialty sector that doesn't work well in a 401(k) plan, because people invest in them when they are hot and then forget about them. "In any niche subsector or specialty sector like REITs, you get people chasing those returns, and then they don't get out and rebalance their account," she says. In general, retirement investors who are intrigued by specialty vehicles don't do well over time, says Hess. "They tend to buy high and sell low."

Keeping in Style
After selecting a mix of 401(k) funds, employers must also track them to make sure they are what they say they are. Some investment committees, after making their initial fund selections, fail to monitor fund managers' performance and behavior afterwards. But so-called style drift, in which a fund manager moves away from a fund's stated objectives and invests in securities outside the targeted sphere, can throw off a plan's asset allocation and leave employees unwittingly overexposed to certain market sectors.

While the problem has diminished somewhat as investors' awareness of it has increased, style drift is still common, particularly in midcap funds, say experts. Small-cap fund managers are often guilty of drifting into the midcap part of the market as their funds grow and they struggle to diversify their holdings, while large-cap fund managers dabble in the stocks of a few smaller companies, looking for the next successful large-cap. For this reason, Walton says she doesn't recommend any dedicated midcap funds to clients, since the sector is often overlapped by other funds.

To guard against style drift, companies' investment committees should regularly evaluate the funds in their plans and compare their performance with a style-specific benchmark — for example, a small-cap fund should roughly track the Russell 2000 index. "If your fund is significantly outperforming or underperforming that benchmark in a given year, that's a good indication that it may not be in the style you expected," says Verhaeghe. While a fund could outperform or lag its peers for any number of reasons, "you should be asking the reason why," he says.

One approach some companies are taking to both rein in costs and avoid style drift is to offer investment options through collective trusts instead of mutual funds. Collective trusts, which are ERISA-qualified vehicles that are only available to institutional investors like 401(k) plans, have long been used by defined-benefit plans. Because they are meant for an institutional audience that is highly attuned to the issue of style drift, collective trusts tend to be more style-pure than mutual funds.

Collective trusts have not been widely used in the defined-contribution market, because employers were concerned about the lack of public information about their performance, but the growing availability of fund data on company Websites and from financial-information providers like Morningstar has eliminated that obstacle. As a result, collective trusts are now starting to cross over into defined-contribution plans as employers focus more on lower-cost options, with 41 percent of plans using them in 2006, up from 32 percent in 2003, according to research from Morningstar and Greenwich Associates.

"In many cases, collective trusts have the exact same manager as a mutual fund, but they are a different type of vehicle," says Hewitt's Hess. Because they are not publicly traded, there are fewer regulatory and administrative costs associated with collective trusts, which results in lower fees. They also have more-flexible fee structures, with lower costs for plans with more assets.

For the Savviest
For the most sophisticated plan participants, some employers are now offering self-directed brokerage accounts within their 401(k) plans. While only about 18 percent of employers currently offer such an option, the number is growing, says Hess. Just 2 percent of employees use the brokerage option when it is available, but it is a good way to appease the savviest investors, who also tend to be the most vocal, she says.

"If you're making a big change in your plan and reducing the number of funds, there are going to be people in the plan who are downright upset, and it tends to be the people with the bigger balances," says Hess. The average user of self-directed brokerages has $100,000 in plan assets, compared with about $80,000 for the average 401(k) participant, according to Hewitt.

Users of the self-directed brokerage option typically pay a fee, and they may sign an agreement that acknowledges that the responsibility to research investments lies with them, not the plan sponsor. By providing the vocal minority with the option to invest in a wide array of funds or securities that have not been screened by the company, employers can then comfortably pare down their core plan offerings to the 10 or 12 funds that will meet the needs of most employees. Those employers who are concerned about the risk that comes with a self-directed brokerage account can set limits: employees may be restricted to investing only in mutual funds, or there may be a cap on the percentage of their contributions they can devote to the brokerage account.

For most companies, however, the greatest challenge of providing an effective 401(k) plan lies not with the savvy few, but with the unsophisticated many. The Labor Department notes that fully a third of eligible workers do not even participate in their companies' 401(k)-type plans. Revisiting a plan to make sure it has a reasonable mix of funds, and an approachable structure that will encourage savings and participation, is a good way to get those workers on board.

Kate O'Sullivan is a senior writer at CFO.

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Sobering Statistics

With guaranteed pensions rapidly becoming a thing of the past, 401(k) savings will be all many workers have when they reach retirement, aside from a Social Security benefit. But utilization and savings rates continue to lag far behind where they need to be to replace employees' incomes. Fidelity Investments, the 401(k) behemoth, provides the following statistics about the 10.1 million participants in its plans in 2006:

• $66,500 — Average account balance

• 63.1% — Average plan participation rate

• 7.0% — Average percentage of salary invested by participants

• 20% — Percent of participants invested 100% in their plan's default option

• $78,800 — Average compensation of plan participants

Source: Fidelity Building Futures VIII

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The Best Mix

Retirement-plan advisers urge employers to keep their fund offerings simple so as not to scare off participants. For a streamlined but effectively diversified 401(k) offering, experts suggest choosing one or two funds from each of the following categories:

• Domestic equities, possibly broken out into value and growth funds or small-cap and large-cap funds

• Domestic bonds

• International equities

• Stable value/capital preservation

• An index fund

• A series of lifecycle funds

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Four for Default

A new regulation issued in October under the Pension Protection Act specifies four qualified default investment alternatives for 401(k) plans:

1. A product with a mix of investments that takes into account the individual's age or retirement date (for example, a lifecycle fund)
2. An investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual's age or retirement date (for example, a professionally managed account)
3. A product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual (for example, a balanced fund)
4. A capital-preservation product for only the first 120 days of participation

Source: U.S. Department of Labor

Over the next dozen years, baby boomers, those trend-setting, iconoclastic, and often sharp-elbowed children of the Greatest Generation, will leave the workforce in droves. Unlike their parents, many won't get a regular pension check. Enrolled predominantly in defined-contribution plans, they'll receive a lump sum of money — an approach that will benefit some but put many others in fiscal peril.

Minus the security of a check, millions of boomers will confront longevity risk — the possibility of outliving their assets. They must manage that lump sum to last a lifetime, not the easiest thing to tackle in one's 70s, 80s, and beyond. Rising concern over employees' post-retirement welfare is prompting companies, and the federal government, to help workers in their last working years make the right decisions about their future needs.

To be sure, the emphasis is on information and communication, but some companies are taking more-concrete steps. Some are tapping new annuities that essentially convert a defined-contribution plan into a defined-benefits plan. Others are pushing programs that provide for catch-up contributions to 401(k)s. And many are helping employees make better retirement decisions.

Behind these efforts is a recognition that the elimination of defined-benefits plans comes at a cost. Given economic uncertainty and the fact that people live longer, there are no guarantees that retiree money will last a lifetime. To fill the void, says Jack Brennan, CEO of Vanguard, companies need to both develop a "philosophy" about dealing with retiree money and implement programs to help employees transition from savers to spenders. "You want your employees to be successful in retirement because they will still impact morale after they are gone," he explains. But companies must be cognizant of the fiduciary responsibility embedded in offering retirement guidance — and employees must accept the risk of a possible shortfall.

Wanted: A Stream of Income
Defined-benefits plans relieved retiree apprehension in the past, with past being the operative word. In the past two years, one third of plan sponsors surveyed by the Employee Benefits Research Institute have closed or frozen their defined-benefits plans. And McKinsey & Co. estimates that by 2012, 50 to 75 percent of private-sector defined-benefits plan assets will be frozen.

In their place, of course, are defined-contribution plans, which now hold 70 percent of the $11 trillion in boomers' invested assets, according to Prudential Financial. Many retirees tend to roll over these assets into an IRA or cash in the proceeds. But a survey of 401(k) participants by Mercer indicates that 80 percent are "less than comfortable" making retirement investment decisions. And 70 percent of preretirees in a Prudential Financial survey wished they had an "autopilot plan" defaulting them into a lifetime income program.

Such insecurities have led to the introduction of products such as target-age or life-cycle funds, which automatically rebalance 401(k)s, as well as a renewed interest in annuities. In fact, in the last year providers have taken the tarnish off the latter, restoring some luster to a much-maligned product. Whereas yesterday's annuities stopped payment upon death, for example, newer versions allow beneficiaries to receive payments. And employers are helping by leveraging their clout, offering annuities as a company benefit. "You have a lot more buying power if you're General Motors rather than John Smith," says George Castineiras, senior vice president at Prudential Financial.

Medical Associates, an 80-year-old multispecialty clinic, found a solution in IncomeFlex, which it introduced last year. Sold by Prudential Financial, the annuity not only provides a steady income for life, it guarantees that the notional value of an employee's 401(k) assets — or as much as they invest — will not be reduced by market performance. When a participant retires, he is guaranteed a steady lifetime annual withdrawal based on the highest of three values: the market value, the highest value of the assets on the person's previous birthdays, or the 5 percent income growth value. In return, the insurer will guarantee a 5 percent minimum withdrawal, starting at 65, for the rest of the retiree's life.

The plan was introduced to the 400 Medical Associates employees past the age of 50. And of the 53 who initially signed on, says CFO Jeff Gonner, most said "they'd rather have Prudential be in charge of their investments than themselves." The employees didn't go into the plan half-heartedly, either. "While they could have put a conservative percentage in the Income-Flex option, they put in 96 percent on average," the CFO notes.

Despite the improvements, annuities aren't without both downside and risk. The downside to annuities is their cost. Employees pay an annual premium, 95 basis points in this case — or nearly one percent of assets — to Prudential to manage their money. Risks include the possibility of inflation topping 4 or 5 percent or, says Joseph S. Adams, a partner at McDermott Will & Emery, "if the provider goes under." In that case, there are state insurer guaranty funds to pick up the payments. "However, there is always the risk the guaranty funds may not be able to provide 100 cents on the dollar if numerous insurers file for bankruptcy at the same time."

Playing Catch-Up
Whether any additional pension or 401(k) relief will be introduced by the next President remains to be seen. But the easing of certain regulations has allowed soon-to-be retirees to pad their savings. In 2001, for example, the Internal Revenue Service amended its rules to permit people 50 years and older to squirrel away more in their defined-contribution plans. For traditional safe-harbor 401(k) plans, participants can now save an additional $5,000. For simple 401(k)s, an extra $2,500 is permitted. "It's great because as you get closer to retirement you can contribute more on a tax-deferred basis," says Hess. "Our research indicates that 90 percent of employers now offer catch-up strategies."

The Boeing Co. is one. "We encourage employees age 50 or older to take advantage of catch-up contributions to accumulate more dollars on a tax-deferred basis," says Pam French, director of benefits and integration. Such plans, adds Alan Glickstein, senior retirement consultant at Watson Wyatt Worldwide, are especially helpful for "second-wage earners, where you can defer relatively large amounts of pay and take advantage of the tax benefit."

New regulations regarding automatic enrollment also help cushion savings. The IRS now permits employers to automatically enroll employees in defined-contribution plans, provided employees are notified in advance and permitted to opt out. Companies can even enroll existing employees in a target-date retirement account. "While it costs companies more to automatically enroll because their matching contributions go up," says Hess, "from an altruistic standpoint they're helping the workforce have the means to retire." Still, there are some indications that the savings rates of aggressive investors could be adversely affected, since the default rate may be less than their previous savings rate.

The Aerospace Corp., a Los Angeles–based defense contractor, has found another way to help retirees ease into retirement: phased-in retirement. "We allow our employees who retire to come back and work up to 999 hours a year, which we understand is allowable under ERISA and Department of Labor guidelines," says CFO Dale Wallis. "We draw upon their valuable skills; they conserve more of their retirement money and get paid to boot."

Phased-in retirement plans, however, are still in their infancy because of government regulations. For instance, an employee covered by a defined-benefits plan cannot participate. Nearly two-thirds of employers in a survey by the Employment Policy Foundation said they were stymied by regulations when offering such programs. But they are invaluable in certain industries. "If you're running a hospital and have a group of nurses all reaching retirement at the same time, it may not be in your best interest to have them all retire at once," says Glickstein. "[Under these programs,] you can give them a smaller workload and they can partially tap their retirement funds, preserving the remainder for full retirement."

Back to the Future
Aerospace did something even more radical: it reinstated its defined-benefits plan. "It's in our customers' best interests that our employees stay a long time, to give corporate memory to the government's space and missile programs," Wallis says. "We didn't want to lose workers to competitors offering a more secure retirement package."

The nonprofit unveiled a defined-contribution plan in 1993, the year it put its traditional pension in a soft freeze, meaning it was closed to new entrants but current employees could continue to accrue benefits. Employees hired before 1993 could rely on the usual bimonthly check; those hired after would accrue a lump sum upon retirement based on contributions made to their plan. "Many plan on living 20 more years after retiring," says Wallis. "But what if they live another 30 years? What do they do those last 10 years?"

The company answered those questions by partially thawing its pension plan for new employees. "New employees now get a 50/50 plan that is half defined-benefits and half defined-contribution," the CFO explains. "They get both the lump sum at retirement plus a pension check for the remainder of their lives."

The new plan also offers significant retention benefits. The government's Base Realignment and Closure Act almost caused the relocation to Colorado of Aerospace's primary customer, a U.S. Air Force base in Los Angeles. "The base represented more than half of our revenues, and we were across the street," Wallis notes. "Had it moved, they would have wanted Aerospace's people, our intellectual capital, to move with them. A defined-contribution plan doesn't give you the handcuffs to do that, whereas a defined-benefits plan provides far more incentive to pull up stakes."

Focus on the Fiduciary
Don't expect a rush of companies to follow Aerospace's lead. Instead, Vanguard's Brennan believes that demographic realities will prompt financial-services firms to develop new products at a "fast and furious" pace. With them, however, will come some fiduciary risk.

"Although plan sponsors have no obligation to deliver a certain amount of retirement income to participants, if they help employees plan their retirement-income streams, they should be careful not to run afoul of fiduciary duties under ERISA," says McDermott's Joseph Adams. "No good deed goes unpunished. Once companies begin to offer things like target-age funds, annuities, and [predictive] tools, there is an element of risk."

Consider the fiduciary obligation linked to offering an annuity. When an employee rolls over a 401(k) or cashes out, employers can rest easy from a fiduciary standpoint — they no longer must monitor the assets — whereas with the annuity, Adams says, they may need to continue to ensure the provider is delivering what it promised. "Similarly, if the plan sponsor decides to add a mutual fund with fixed payouts, companies will need to ensure that they comply with fiduciary duties of prudence in selecting the fund and monitor performance for as long as the fund is an investment choice."

Adams suggests that companies wield the "disclaimer" word often. "You need to inform employees that the predictive modeling tools are simply that — predictive," he says. Still, adds Glickstein, "there is plenty of room for employers to provide customized information and programs to help employees through this."

Russ Banham is a contributing editor to CFO.

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Smoothing the Transition
Products and Services for the Soon-To-Be Retiree

Life-cycle funds. These funds automatically reallocate as an employee ages. For someone in the last five years of employment, UBS Global Asset Management advocates a broadly diversified portfolio comprising both U.S. and non-U.S. equities; exposure to emerging markets (both debt and equity); real estate (including real estate investment trusts); high-yield bonds; and Treasury inflation-protected securities, with equities slightly outweighing bonds at 55/45 percent.

Retaining retirees' 401(k)s. Employees can often opt to leave their 401(k) balance with the plan sponsor instead of rolling it over. The advantage is that the company has a fiduciary obligation to monitor the assets, and the employee has access to lower-cost funds.

Web-based tools. Companies and plan administrators have introduced a slew of tools to gauge retirement costs versus savings. At The Boeing Co., for example, one tool models the defined-contribution plan over time, based on different savings rates and investment strategies. Another models the participants' pension and invested assets at different ages of retirement.

In-house advice. Some companies are offering specialized human-resources advice for employees nearing retirement. At Boeing, a retirement advocacy service in human resources walks employees through the retirement process. There is also a separate team of HR specialists who help employees understand different financial strategies for a secure retirement. — R.B.

The Labor Department announced its final rules designed to make it easier for employers to automatically enroll workers in 401(k) and other defined-contribution plans.

The rules, a result of last year’s Pension Protection Act, seek to clarify the kinds of default investments in which employers can stash assets of employees under automatic-enrollment plans.

“This is a key component of the Pension Protection Act and will help many more workers and their families build a nest egg for a secure and comfortable retirement,” said U.S. Secretary of Labor Elaine Chao.

According to the department, about one-third of eligible workers do not participate in their employers’ 401(k)-type plans. It pointed out that studies suggest that automatic-enrollment plans — in which workers opt out of plan participation rather than opt in — could reduce the non-participation rate to less than 10 percent.

The act permits employers to automatically enroll employees and place their assets in qualified default investment alternatives, or QDIAs. The QDIAs will encourage the investment of employee assets in investment vehicles appropriate for long-term retirement savings, the Labor Department explained.

Under the rules, participants and beneficiaries must have been given an opportunity to provide investment direction, but have not done so.

The final regulation does not identify specific acceptable investment products. Rather, it describes mechanisms for investing participant contributions. “The intent is to ensure that an investment qualifying as a QDIA is appropriate as a single investment capable of meeting a worker’s long-term retirement savings needs,” the department said.

Each investment product must be a mix of investments that takes into account the individual’s age or retirement date, such as a life-cycle or targeted-retirement-date fund.

Also, it must be an investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual’s age or retirement date. One example the DOL noted is a professionally managed account.

Another type of acceptable QDIA is a product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual, such as a balanced fund.

Finally, Labor Department has approved for these retirement investments what it described as a capital preservation product for only the first 120 days of participation. This is an option for plan sponsors wishing to simplify administration if workers opt out of participation before incurring an additional tax.

A QDIA must either be managed by an investment manager, plan trustee, or plan sponsor who is a named fiduciary, or be an investment company registered under the Investment Company Act of 1940.

A QDIA generally may not invest participant contributions in employer securities.

The Labor Deparment also said that plan sponsors that adopted stable value products as their default investment prior to passage of the Pension Protection Act and the final regulation will be provided a transition rule. This “grandfathers” these arrangements but does not provide relief for future contributions to stable value products.

The final regulation also clarifies that a QDIA may be offered through variable annuity contracts or other pooled investment funds.

In an effort to bring "hidden" or excessive 401(k) fees to light, the Department of Labor on Thursday proposed requiring retirement- benefit-plan service providers to make added disclosures to plan fiduciaries. The aim is to help the plan sponsors gauge the reasonableness of what they pay the service providers and identify conflicts of interest that could affect their performance.

If adopted, the proposal would benefit retirement plans by possibly lowering their fees, increasing the efficiency of plan-service provider relationships, and reducing the costs of evaluating service providers, the DOL asserted.

"We are working quickly to implement regulations that foster fair, competitive and transparent prices for services as well as combat excessive or hidden plan fees," said Secretary of Labor Elaine Chao.

Under the proposal, in their contracts with 401(k) or other retirement benefit plans, service providers would have to provide specific, detailed information about all services to be performed and all compensation to be received either directly from the plan or from third parties. The proposal includes a definition of "compensation or fees" and a rule for estimating the prospective amount of compensation.

Service providers also would have to describe any participation or interest they might have in transactions to be entered into by the plan; any material relationships with third parties that could create conflicts of interest; any compensation they might get without the plan fiduciary's approval; and any policies or procedures they have that address potential conflicts of interest.

The weakening American economy is beginning to take its toll on corporate employees where it hurts the most: their salaries and savings.

The latest Duke University/CFO Magazine Global Business Outlook Survey, which polls 573 finance chiefs in the U.S. and 1,275 globally, finds that year-end employee bonuses will fall by 10 percent this year compared to 2006. That decline could be especially painful at a time when more employees are dipping into their retirement accounts in order to pay bills.

The survey finds that nearly 20 percent of companies have seen increased hardship withdrawals from 401(k) accounts, often to cover mortgage payments or to avoid personal bankruptcy.

"In the last four or five months we have seen an absolute onslaught of people trying to do hardship withdrawals and loans out of 401(k)s," Mark Anderson, CFO of Granite City Electric, told CFO magazine in October. "What has happened with housing and the economy has really blown up for people at the lower end of the spectrum."

CFOs attribute the 401(k) withdrawals to the effects of the shaken credit markets and higher costs of living, among other reasons. Those concerns have affected companies from top to bottom. Nearly a third of CFOs polled in the survey said their firms have been directly hurt by credit conditions.

To make up for the prospect of slower growth in the future, many companies will raise prices and look for possible mergers. The survey finds that companies expect to raise the prices of their products by 2.8 percent in 2008, an increase from the 2 percent expected in the previous quarter. Meanwhile, 40 percent of U.S. firms said they would seek to buy either all or part of another company.

Corporations have long enjoyed tax credits for reimbursing employees' tuition expenses for education related to their current job. But now, with the skills needed in the workplace changing seemingly by the month, whether that's sufficient is debatable.

And so, for the first time, a corporation is planning to provide a 401(k)-type program whereby employees could contribute to an interest-bearing education account. The account, which would be supplemented by company-paid matches, would be used for any professional skill development not related to the employees' existing job. And it’s not just any corporation, but the one whose human-capital strategies arguably draw more attention than any other: IBM.

The rules: at the outset, the program will be just for U.S.-based employees, who must have five years of service to participate. They will be able to contribute up to $1,000 a year from their pay, and IBM will match 50 cents on the dollar. (The company will continue spending $600 million a year on tuition reimbursement for current-job enhancement.) Employees will decide what courses to take, though IBM has not yet defined what constitutes "professional skills." It has some time to figure that out, as the program doesn't launch until next July.

That will also buy time to overcome the big catch: getting the government to pony up a tax break for plan contributions, à la a 401(k). That ball is rolling, with legislation proposed by Rep. Rahm Emanuel (D-Ill.) and IBM mounting a lobbying effort.

"Now more than ever, workers must continually update their skills and seek any opportunity that allows them to develop abilities that will be valued by a wide range of employers," the congressman wrote to his colleagues in proposing the legislation. "Workers that invest and innovate in their own human capital will do well in a global economy. Unfortunately, many workers today don't have the resources to seek out new skills or opportunities."

The outlook for getting a bill introduced and perhaps passed in 2008 calls for at least modest optimism. "A lot of the Presidential candidates are promoting access and favorable financing for education, so this is clearly in the air," says Randy Harrison, managing director of Capital H Group, a Chicago-based human-resources consultancy.

IBM is thought to be the first company to offer an employee-funded education program with a company match, and because of its high profile, other companies will be watching closely for the outcome, adds Harrison.

IBM says its motives are corporate citizenship and providing another channel for workers' improvement. "For our employees to get an expanded skill-set to be effective in a global economy, we have to do more than the job-related spending," says Stanley Litow, vice president of corporate citizenship and corporate affairs. "People also need training for the jobs that may exist in the future."

Litow acknowledges that some employees might train themselves right out of the company, but says the assumption is that far more will prepare for new career paths within IBM. However, he says, the company will gladly support employees in any professional skill development direction they choose to take, including educating themselves for different careers.

Virtually everyone would agree the program is a positive development. But just how positive?

One interested observer likens it to such benefits as corporate concierges and pet insurance. "The average college course costs $1,000, and most training courses are even more, so people might be able to take one a year," says Faith Ivery, president of Educational Advisory Services in Scottsdale, Ariz., which consults with companies on employee education. "It's a nice little perk, and there's nothing wrong with it, but if IBM thinks this is actually going to create a new set of skills for someone to move into a new job or develop intensified skills to take on new authority, they're wrong."

Emanuel apparently agrees. His legislative proposal calls for allowing employees to contribute up to $2,500 annually. And the more money that's in the pot, the more people will be motivated to get educated. "People will reach a point where they decide they have to take some classes, so the money won't go to waste," says Dallas Salisbury, CEO of the Washington-based Employee Benefit Research Institute.

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Since the launch of the 401(k) in 1982, participants have been required to make most of the major decisions about funding and managing their plans themselves. Twenty years of evidence shows they nearly always do it badly, but until now the law prohibited plan sponsors from offering all but the most cursory advice.

No more. Passage of the Pension Protection Act (PPA) last August gave plan sponsors strong incentives to build a range of automatic enrollment, escalation, and rebalancing features into their 401(k) plans, along with a default selection of investments. Since 401(k) and other defined-contribution plans now serve 84 percent of all U.S. employees who have corporate retirement plans, the PPA in effect restores some of the paternalistic employer management characteristics of the defined-benefit era.

The added burden may be worth it. The PPA provides employers with a fiduciary safe harbor that increases their comfort level in taking a more active role in employee retirement planning. Currently, as much as 20 percent of plans automatically enroll employees; employees must opt out of a plan to avoid participating. About 15 percent of those plans provide for automatic increases as salaries rise. With the impetus from the PPA, those percentages are likely to climb sharply in the next several years, especially among plans with fewer than 1,000 participants.

"From the employers' perspective, there's no reason to wait, now that they have clear fiduciary operating guidelines and a safe harbor," says Jamie Cornell, senior vice president of employer marketing for Fidelity Employer Services Co. He already sees a change in employer attitude among Fidelity's plans. (With 13 million total participants and 20,000 corporate plans, Fidelity is the largest plan provider.) Fidelity, a big winner when plan participation grows, is pushing hard for more plans to join what it calls "the next generation" of retirement savings.

The PPA also sets guidelines under which companies can arrange for individual advice to be offered about retirement investing. "The early adopters of automatic enrollment are celebrating the fact that they've seen 90 percent and 95 percent plan-participation rates," adds Cornell, comparing them with more-typical rates of 60 percent or so in the past. "Now they're using the plan's design to influence participant behavior" and boost savings. Some sponsors, for example, are requiring participants to contribute at least 6 percent of salary to qualify for a company match of invested dollars. This amounts to doubling the average deferral rate. Fidelity's goal is to raise the average deferral rate to 6.9 percent. "We'd like to see people eventually saving upwards of 10, 11, or 12 percent toward retirement," says Cornell. Among current participants in plans, Fidelity calculates, 92 percent don't maximize their contributions and 86 percent don't rebalance their accounts from year to year.

A Paradigm Dies Hard
The rationale behind this dramatic reform of the retirement-savings system involves making inertia work for employees, whose biggest problem has been failure to sign up for a plan. "Adding the automatic enrollments should bring participation percentages into the high 90s for any sponsor," says Robert Liberto, senior vice president at Segal Advisors, the investment consulting arm of Segal, and a provider of investment services to corporate and public-sector pension-plan sponsors.

Despite the company matches, investor education, and other perks that characterize most 401(k) plans, "the driving partner in the process was always the participant," says David Wray, president of the Profit Sharing/401(k) Council of America. "But now, the employer is really becoming the senior partner in the relationship. It will make decisions about what is considered standard unless the employee chooses something different. That's 180 degrees from the way it was. It really is a form of corporate paternalism."

With the PPA, observes Steve Utkus, principal of Vanguard's Center for Retirement Research, "Congress has jumped on the work that has come out of the private sector and academic research." Its action is based on a wealth of studies that examined employee saving patterns and offered "a more profound and subtle understanding of why people are not good planners."

Even with the government giving its blessing to automatic plans, though, Utkus still often finds corporate 401(k) investment committees a hard sell. "Philosophically, many committees are in the 'neutral vessel' mode as plan sponsors," he says. "The committee members say, 'We really don't want people in default funds; we want them to make their own choices.' The old paradigm dies hard."

Vanguard has more than 4,000 institutional clients with a total of at least 3 million participants. In the past, it has stressed automatic 401(k) features among the 1,800 of those that are record-keeping clients, says Utkus, and about 150 already have automatic enrollment and escalation components. "We'll have north of 25 percent of clients adopting the automatic approach in three years," he predicts.

Corporate education programs about employee retirement saving should get a boost from the shift to automatic plans, as the PPA intended. "When enrollment isn't automatic, there's a problem getting employees to change their behavior," he says. "Now, you'll be starting with a room full of people who are already on the right course. The education becomes supplemental, and reaffirms what they're doing. You can say, 'If you want to be more aggressive, here's how. If you want to be more conservative, here's how.'"

Consenting to Advice
Memphis-based FedEx recently announced automatic enrollment for its 120,000 401(k) participants as part of a PPA-inspired buildup of its plan. "This is something we've wanted to do for a long time," says Alan B. Graf Jr., executive vice president and CFO, who had been perplexed by the low 60 percent sign-up rate of eligible employees. "You would think a 50 percent return would be an obvious choice for employees," he says, noting the current 50 percent match terms for 401(k) contributions up to $500 currently. "We just weren't able to go far enough to educate people and help them make their savings build. Now at least we'll be starting them the other way — toward saving."

On January 1, 2008, FedEx also will sweeten the terms of its match to 100 percent of the first 1 percent of eligible earnings and 50 percent on the next 5 percent. "I'm one of those people who believes you can't save too much for retirement, given how health-care and other costs are rising so sharply," Graf says. Noting that 14,000 members of the current plan have all their retirement money in a money-market account, he is also happy that FedEx will have a diversified default-investment option. He acknowledges that increasing employees' market risk — especially after February's Wall Street shock — may take some explaining. "People say they just don't understand the market," he says, "but we think we can show them there's enough diversity in the portfolio to protect them from much of that risk."

FedEx, which has Vanguard as its 401(k) provider, is talking with various vendors about offering computer-modeled investment advice to employees, who would then be able to use a telephone hotline for more-specific guidance. It is taking its time, however, as the market for such advice programs develops.

Despite the PPA's encouragement of more advice, Fidelity and other large vendors have seemed reluctant to enter the third-party advice field. "The vendors aren't exactly doing back flips," says John Nixon, a benefits partner with the Philadelphia law firm WolfBlock. "There are tons of vendors that could provide advice, but I don't think they feel comfortable yet with the initial guidance from the Department of Labor."

David Wray says a healthy advice system already serves plan sponsors, using computer models and telephone hotlines and sometimes drawing on more-expensive face-to-face consultations. Nixon, however, believes the "advice market" could take off if a large vendor jumped in with a program.

Cost may not be as big a factor for Fidelity as the need to adjust compensation structures for its advisers if 401(k)-related advice programs were to become popular. "Right now, we are evaluating the situation," Fidelity's Cornell says.

But even as FedEx reviews advice options, its main thrust now is to communicate with employees about its reshaping of the plan in general.

"We are well aware that when you talk to people about changing their retirement savings it makes everybody nervous," says CFO Graf. "Our communication is going to be very intensive. I told our employees that we're going to answer every last question about it."

Roy Harris is a senior editor at CFO.

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Some 16.7 million baby boomers will retire by 2010. As they dial up their hearing aids to groove to their old Beatles CDs, many will be drawing income from a combination of Social Security, traditional pensions, and one or more 401(k) savings plans. As they juggle those sources of income, they may want to leave "Let It Be" on repeat play. Many employees cycle out of their 401(k) plans and into an individual retirement account, believing that it simplifies their personal finances.

But a rollover into an IRA may not be the right choice, for several reasons. Lower plan-service costs for 401(k)s; the sponsor's fiduciary obligations; and the ability, courtesy of last year's Pension Protection Act, to continue 401(k) benefits to spouses who outlive the primary beneficiary, make 401(k)s more appealing. (Prior practice required spouses to cash out upon the retiree's death.) The legislation also permits plan sponsors to offer advice to employees and retirees about their investment choices.

Companies like IBM have latched onto this aspect of the pension act. In March, Big Blue announced a multimillion-dollar personal-finance and educational program called IBM MoneySmart to help its U.S. employees better plan their retirements; in January, the company will freeze its traditional pension plan and switch entirely to a 401(k) plan. "Employees need to recognize the importance of managing their 401(k) assets," says IBM finance chief Mark Loughridge. As do employers: "From a fiduciary standpoint, it is becoming clearer that companies must ensure their plan participants are taken care of," says Kathy Himsworth, principal of the institutional investor group at Vanguard.

IBM has taken a lot of flak over its decision to freeze its pension plan, following years of trying to pare it down. Like other companies, IBM must balance pension costs against employee-recruitment and -retention issues. In IBM's case, a beefed-up 401(k) plan with a dose of financial education is the solution.

Propelled by FAS 158 and the Pension Protection Act, many companies are putting more thought into their 401(k) plans, educating employees about their options at every step and working to keep assets within the plan, thereby giving them more negotiating clout with plan providers.

The emphasis on defined-contribution plans doesn't spell doom for IRA rollovers, which are expected to reach $7 trillion by 2011, much of it generated by 401(k) dollars. IRAs offer retirees the ability to cash out their 401(k) plans and invest the proceeds in a potpourri of stocks, bonds, annuities, and mutual funds of their choice, an investment portfolio far broader than the average 401(k) program. Even more tantalizing is the ability, courtesy of the pension legislation, to convert traditional IRAs by 2010 into Roth IRAs, which allow tax-free distributions for those who are older than 59 and a half.

But the IRA's positives are also its negatives. "An IRA offers hundreds if not thousands of investment choices," says Jamie Cornell, senior vice president of employer marketing for Fidelity Employer Services Co. "The more investment opportunities are provided, the more overwhelming they are."

Too many choices may be as unwise as too few. "People in a 401(k) plan are in an Olympic-size pool with clearly marked lanes; putting them into an IRA is like taking them in a helicopter, dropping them into the Pacific, and saying 'Good luck, find your way home,'" says Eric Levy, head of the Mercer Securities division of MMC Securities Corp. Several studies posit that the more investment options you give employees — à la IRAs — the less likely they are to save. In a 2003 study of employee-participation rates in 401(k) plans by Columbia University researchers Sheena Iyengar and Wei Jiang, participation rates in 401(k) plans fell 1.5 to 2 percent for every 10 funds added to the plans.

It also may not be a good idea for companies to advise retiring employees to cycle their 401(k) funds into IRAs. "Some plan sponsors are concerned that an IRA rollover may be construed by employees and retirees as an implicit endorsement of a particular investment vehicle, thereby creating a liability if the IRA loses money," explains Ray Martin, president of CitiStreet Advisors, the registered investment advisory and recordkeeping entity within CitiStreet LLC.

Dad's Retirement
By comparison, the Greatest Generation (a.k.a. parents of the boomers) had it easy: guaranteed pensions via defined benefits provided by employers, plus Social Security. Checks arrived in the mail every couple of weeks, providing a steady cash flow not dissimilar to the biweekly paycheck. When 401(k) plans debuted nearly 30 years ago, they were icing on the cake. Today, they're pretty much the cake.

No longer can many retirees rest easy knowing their future incomes are secure. Instead, they have to give their retirement assets deep thought, which is not something everyone does well.

According to a 2005 survey by the Employee Benefit Research Institute, more than half of employees (55 percent) describe themselves as being "behind schedule" when it comes to planning and saving for retirement, with 32 percent saying they are "a lot behind schedule." That's scary, considering that another 69 million will retire by 2025, according to Tom Modestino, senior analyst at Cerulli Associates in Boston.

Hence the new thinking about keeping assets in 401(k)s. "Moving plan participants from an institutional environment — where they are protected under the [Employee Retirement Income Security Act] and can leverage the sponsor's buying power and lower fee structures — into a retail environment, where they are left naked and have all kinds of choices and costs, is being questioned," says Modestino.

But I've Got Four 401(k)s
In essence, about-to-retire workers can choose to: (1) keep invested assets in their 401(k)s, (2) consolidate these assets into an IRA, (3) cash out, or (4) all of the above. Each has its advantages and drawbacks, which is why employee-investment education like IBM's is emerging as a vital employee benefit. Big Blue teamed with Fidelity Investments and The Ayco Co., part of Goldman Sachs, to develop MoneySmart.

Of course, for sophisticated finance people like CFO Bill Ferko, managing several 401(k) plans in retirement is not difficult. "I've accumulated three 401(k) plans over my career," says Ferko, CFO of Genlyte Group, a Louisville-based manufacturer of lighting fixtures with $1.6 billion in annual revenues. "I expect to leave these assets in the plans and not roll them over."

Genlyte wants to help its employees in much the same way Ferko helped his father with retirement choices. "We publish newsletters and regularly communicate about their retirement investments. We've also introduced an online system [that enables] people to check their balances hourly," says Ferko.

MassMutual is assisting its own and others' employees in a slightly different way, by reinstating the bimonthly check in the mail. The concept, called retirement management accounts, is currently in a pilot stage. It endeavors to assist employees in determining how much income retirees need each month, then draws from their retirement assets to provide those funds. As people's lives change, they can increase or reduce this cash spigot, pulling out more, say, for assisted-living needs or the grandkids' college tuition.

Spruced-up 401(k) plans add some competition to the retirement-investment game, which is good for baby boomers, Gen Xers, and their heirs. To paraphrase the Beatles, "It's a long and winding road." The key is to not get lost, financially, along the way.

Russ Banham is a contributing editor of CFO.