Firms Can Impose 401(k)s on Workers
Company-sponsored 401(k) plans are one of the best ways to prepare for retirement, but millions of eligible workers aren’t taking full advantage of these programs.
Some people simply never sign up. Others start off with modest contributions and vow to kick in more when a raise comes along, but never follow through on that pledge.
A recent ruling by the Internal Revenue Service, however, gives companies the green light to do more when their workers do nothing.
The ruling, made in what the IRS calls a “general information letter,” allows companies to automatically enroll employees in a 401(k) plan and even hike their contribution levels over the years or when workers get raises or bonuses.
Such power may strike many workers as paternalistic or worse, especially among those who need all of their paycheck just to get by.
But there is an important catch: Although a company can automatically enroll employees in these savings plans, workers can opt out of them at any time.
Karen Ferguson, who as director of the Pension Rights Center in Washington is an advocate for workers, contends that companies are not infringing on employee rights when they push them into 401(k) plans without their consent.
“If employees don’t have something like this, too many of them are going to end up living on nothing but Social Security when they retire -- and that won’t even keep them at the poverty level,” Ferguson said. “In the old days, companies contributed for you. This is the closest approximation available to today’s workers.”
At most companies with 401(k)s, workers are given information about the program and it’s entirely up to them whether to sign up. Automatic enrollment plans work the other way: Unless the employee specifically says no, he or she is placed in the plan.
Paltry balances
The Labor Department and the IRS, which oversee different aspects of pension programs, have never specifically banned automatic enrollment plans. But the guidance they’d provided on what was allowable was scanty, which has limited the automatic plans’ popularity, said David Wray, president of the Profit Sharing/401(k) Council in Chicago.
Although about 7% of companies have automatic enrollment plans, most are operated conservatively, commonly taking 3% of a worker’s salary for the 401(k) contribution, Wray said, when companies often match up to double that percentage.
Fewer than 50 of the nation’s 400,000 plan sponsors have aggressive and escalating enrollment programs that gradually increase the amount of contributions to the plan, he said.
As a result, too many workers near retirement with paltry account balances, he said. They also miss out on the tax advantages of these retirement plans and on lucrative company matching contributions of 25 cents to a dollar for each dollar saved by the employee.
Hoping to encourage more companies to adopt aggressive automatic enrollment plans, attorney and pension specialist J. Mark Iwry asked the IRS for guidance on several issues. Could companies automatically enroll employees and increase contribution percentages each year or when the employee received a raise or bonus?
Yes, replied the tax agency’s manager of employee plans in a March 17 general information letter, so called because it can be applied to other cases as well. The only caveats: The employer must clearly disclose what they’re planning to do, and employees must have the right to opt out at any point.
“This is really an interesting and potentially significant decision,” said Iwry, a senior fellow at the Brookings Institution in Washington and a pension expert at law firm Sullivan & Cromwell. “The whole automatic enrollment phenomenon has been a very significant factor in terms of providing more retirement security in an era when attention is shifting to 401(k)s.”
New Plans Expected
If history serves as a guide, the new ruling will open a floodgate of companies launching escalating automatic enrollment plans, Wray predicted. In the late 1990s, for example, the Labor Department gave a similar stamp of approval to companies wishing to provide investment advice to their workers. (Labor officials regulate the investment side, while tax officials watch over the contribution end of 401[k] plans.) Within two years, the number of companies providing this advice nearly doubled, Wray said. More than half of all 401(k) sponsors now provide investment guidance.
Increasingly, they’re also offering so-called asset allocation funds, which put investment decisions on automatic too. These funds divvy participant money among different types of investments and automatically rebalance portfolios when the mix of stocks, bonds and cash gets out of whack.
“There are lots of things that plan sponsors can do, if they read the law broadly,” Wray said. “But sponsors are reluctant to do those things until there is a specific blessing.”
There are two reasons plan sponsors have been slow to aggressively enroll people in the retirement plan, Wray added. They haven’t wanted to tick off workers who might view automatic enrollment as a pay cut. And they have feared running afoul of pension regulators, who could deny the plan its tax-exempt status and leave the company on the hook for millions of dollars in income tax payments.
Now, there’s not only a regulatory blessing, but there also has been a shift in worker attitudes, Wray said. In the late 1990s, workers clamored for more investment choices, but otherwise they wanted to be left alone to invest their retirement savings independently. But the three-year slide in stock prices apparently left employees with less confidence about their investing skills, he said. They’re now asking for advice on how to invest and how much to invest, he said.
Still, 401(k) sponsors continue to be dogged by a lack of RSVPs, Iwry said. About 1 in 4 workers who are offered a 401(k) plan don’t respond to the invitation.
When the worker doesn’t respond, he or she generally doesn’t participate. That not only puts the nonparticipants retirement at risk, but it also creates problems for the workers who do participate because of so-called nondiscrimination testing within the plans, Iwry noted. Nondiscrimination testing in a 401(k) essentially stops highly paid workers from contributing a much larger portion of their pay than low-paid workers.
The bottom line: Company executives are not allowed to shelter as much income from tax through 401(k) contributions unless they can find a way to get their lower-paid colleagues to contribute significant sums too. Thus, automatic and escalating enrollment plans may provide a benefit to the rank and file, but it also serves managers’ self-interest.
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Growth of 401(k)s
Participation in 401(k) plans is believed to have leveled off in recent years.
*--* Active participants Assets Year (millions) (trillions) 1993 23.1 $0.6 1994 25.2 0.7 1995 28.1 0.9 1996 30.8 1.1 1997 33.9 1.3 1998 37.1 1.5 1999* 39.5 1.7 2000* 41.0 1.7 2001* 42.0 1.6 2002* 42.0 1.5 2003* 42.0 1.83
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*Estimated
Sources: Labor Department, Profit Sharing/401(k) Council of America
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Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past columns, visit latimes.com/kristof.
