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Comment The Post Below...
Greetings,
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.
Best,
Mandi
Be sure to visit the SoHo News and Tips blog!
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Pension Bill Will Bring Big Changes to 401(k)s
By TOM LAURICELLA
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.
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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
party.
DID YOU KNOW?
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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