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Pension Bill Will Bring Big Changes to 401(k)s

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The 401(k) retirement plan, one of the most important savings 
tools available to Americans, is about to get a makeover. 
The most significant change will make it easier for companies 
to automatically enroll their employees in a plan and also 
help companies automatically increase the amount of money 
deducted from employees' paychecks.


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Pension Bill Will Bring Big Changes to 401(k)s 
Staff Reporter of The Wall Street Journal. 

The 401(k) retirement plan, one of the most 
important savings tools available to Americans, is 
about to get a makeover.

Late Thursday night, Congress passed a pension-
reform bill that will transform significant aspects 
of how these plans can operate. Named for the 
section of the tax law that created them, 401(k) 
plans let workers sock away part of their paycheck 
tax-free until retirement. The problem is, too many 
people are making bad decisions, such as leaving 
their money parked in low-yielding investments 
instead of more suitable choices.

Worse yet, millions of workers choose not to 
participate in a 401(k) plan at all, putting their 
own retirement at risk.

The new rules aim to change much of that. Most 
significant, it will become easier for companies 
to automatically enroll their employees in a plan 
and will also empower companies to automatically 
increase the amount of money deducted from 
employees' paychecks.

Meanwhile, the Labor Department, which regulates 
the plans, is on track to let employers automatic-
ally put their employees' money into riskier, but 
higher-yielding, stock and bond funds rather than 
low-yielding money-market funds that have long 
been the default option.

Some of the changes are controversial. For the 
first time, 401(k)-plan providers -- such as 
brokers and mutual-fund companies -- will also be 
allowed to offer specific investment advice to 
their employees. In the past, that has been 
expressly forbidden. The fear was that they would 
recommend investments that maximized their own 
profits or commissions but weren't in participants' 
best interest.

While most of the changes in the 401(k) rules 
officially take effect in 2008, employers could 
begin taking steps to implement many of these new 
features sooner. Indeed, a handful have already 
added these features to their plans with success,
but many have been reluctant to take the plunge 
until they were enshrined in law.

For people who are already participants in a plan, 
all of this means paying extra attention to 
communications from employers: While many companies 
may choose to add the new features only for new 
employees, they can also be put in place for exist-
ing workers. As a result, the particulars of your 
401(k) could theoretically be affected, even if 
you thought it was all set up the way you wanted 
it. It isn't just 401(k)-plan participants who are 
affected by the new rules. They also affect so-
called 403(b) plans, which are retirement plans 
for nonprofit workers and educators.

The reforms mark a significant change in the 401(k) 
philosophy. Created as an alternative to company-
run pension plans, the aim was to give employees 
direct control over their retirement money.

That attitude has shifted. Study after study 
indicates that many workers aren't good at the do-
it-yourself decisions demanded by 401(k) plans: 
Young workers leave their money in low-yielding 
accounts, and older workers end up too heavily 
loaded up in their company's stock.

On top of that, the dot-com bust and bear market 
crushed many Americans' retirement savings, just 
as concerns started arising about the future of 
Social Security. It added up to increasing import-
ance for 401(k) plans as retirement safety nets.

Ironically, many of the new features are taken 
from the very thing that 401(k) plans were designed 
to replace: "They're taking on the best features 
of traditional pension plans," says John "Jack" 
Callahan of Fidelity Investments' Institutional 
Retirement Services Co.

Continued below....


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Here are some features likely to become common.

Automatic enrollment: At companies offering a 
traditional pension, employees are generally auto-
matically enrolled. But 401(k) plans typically 
require new employees to sign up, which can be a 
tough sell for younger or lower-paid workers. 
There are 12.1 million people in the U.S. eligible 
for workplace retirement plans who don't partici-
pate, according to the nonprofit, nonpartisan 
Employee Benefit Research Institute.

In fact, many states bar companies from taking 
money out of an employee's paycheck without written 
consent. It is a leftover law from the bad old days 
when unscrupulous employers would force employees 
to buy things like food or clothing from a company-
owned store at extortionist prices, says Fred Reish, 
an attorney specializing in retirement-plan law.

The pension-reform bill changes that, allowing 
automatic enrollment. Employees can opt out of the 
plan, but retirement experts say that once people 
are in a plan, they are likely to stay put simply 
out of inertia. The idea, says Christopher Jones 
of investment-advisory firm Financial Engines, is 
to "flip inertia from being a force of evil into 
a force of good."

With automatic enrollment, participation in 401(k) 
plans could jump from 66% of eligible employees to
about 92%, according to estimates done by EBRI and 
the mutual-fund industry's trade group, the Invest-
ment Company Institute.

Automatic increases: To address the problem of 
employees not saving enough for retirement, the 
new law makes it easier for companies to auto-
matically increase the percentage of an employee's 
salary that is directed to the plan.

The new rules don't expand the amount of money one 
can put into a 401(k). However, they do encourage 
companies to meet certain minimum requirements for
matching employer contributions as part of the 
automatic increases.

In fact, the new law prods companies (but doesn't 
require them) to meet certain minimum step-ups 
going from a 3% deferral the first year to 4% the 
second year and up to 6% the fourth year. In 
addition, companies are encouraged to meet certain 
minimum requirements when matching the automatic 
deductions with additional employer contributions.

This savings step-up can have a major impact. Say 
a 32-year-old making $30,000 a year joins a 401(k) 
for the first time. If 3% of the person's salary 
is placed into a blend of stock and bond funds 
with a 1.5% match from the employer, at age 67 the 
portfolio would be worth $117,300, according to 
calculations prepared by Vanguard Group. But with 
the minimum automatic increase contained in the 
pension bill and a higher employer match, that 
portfolio would be valued at $238,300 at age 67, 
Vanguard says.

Default investments: Currently, the default invest-
ment in a 401(k) plan is usually a low-yielding 
money-market account. The problem with that is a 
surprisingly large number of people never move 
their money out of that account and into higher-
yielding stock or bond investments they need to 
provide adequate retirement savings.

As a result, the Labor Department is readying 
proposed regulations that would let employers 
default their workers into broadly diversified 
investments. These multi-asset investments include 
several different types of funds: "age-based funds," 
in which a portfolio of other mutual funds is 
tailored to a particular expected retirement date; 
"risk-based portfolios" of funds (such as 
"conservative" or "aggressive"); "balanced funds," 
which are a blend of stocks and bonds; and "managed 
accounts," which are portfolios customized to 
consider not just a person's age and risk-tolerance,
but also other investments.

Advice: The most controversial aspect of the 401(k) 
plan makeover is the provision letting companies 
offer specific investment advice. Under the rules, 
specific investment recommendations can be given 
if they are based on a computer model that must be 
certified as bias-free by an independent third 


You might be tempted to look at your company's profits as 
a means for you to enjoy yourself. This is a scary situation. 
Before you spend, ask yourself this: "If this were other 
people's money and I were the president of their company, 
would I still spend the money this way?"

So what did you think about this issue? Drop me a line and let 
me know at mailto:mandi@gophercentral.com 

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