Sunday, December 23, 2007

Pension Protection Act of 2006 allows employers to make more aggressive investments of 401K funds automatically


The Washington Post, in a story on Business Page F1 today (Sunday Dec. 23, 2007) reports on a new law, part of the Pension Protection Act of 2006, allowing employers to enroll associates automatically in more aggressively managed 401K funds. The story is called “New Law to Expand Reach of 401(k)s: Way Is Cleared for Default Enrollment,” here.
The provisions at hand go into effect Christmas Eve, Monday Dec. 24.

The provision protects employers from liability for investment losses if they invest "automatically, by default" in one of three specific types of funds, which are riskier than the stable value funds commonly used. The concept is called “life cycle balancing” and allows riskier investments for younger associates to be made automatically. The theory is that over time these investments will yield much higher returns, able to support the associate in retirement, as economic variations tend to balance out over time. For example, more aggressive investments could be made in stocks, new technologies, companies in developing countries (especially China and India), or real estate – all of which tend to be risky in the short run but yield much better returns in the long run. As the associate gets older and closer to retirement age (however defined at the time, and it will increase with demographics) investments automatically become more conservative. Stable value investments may not yield enough returns to support associates for longer retirements. Investments also need to start taking into account the possibility of long term care or the need for long term care insurance. Associates must always have the ability to change automatic allocations, however.

My own experience was that I had quite a bit of choice of funds when I was working (for ING) and it was easy to get the changes made, although this was done and confirmed by mail. Employers have started to outsource this kind of work to companies that specialize in managing it (like Hewitt Associates).

Concepts like automatic allocation have long been known in financial services, especially in life insurance with products known as variable life.

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