Human Capital & Careers

Rules Finalized for Automatic 401(k)s

The Labor Department specifies what kinds of investments companies can make for employees under new automatic-enrollment plans.
Stephen TaubOctober 24, 2007

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.