The Pension Protection Act (PPA), enacted in December 2006, has had a major impact on 401(k) plan design and participant savings behaviors, according to an analysis by Fidelity Investments, a provider of workplace retirement plans.
About half (51 percent) of participants in Fidelity-administered 401(k)s were in a plan that offers auto enrollment, up from just 16 percent at the end of 2006.
Additionally, the percentage of plans defaulting participants into age-based target-date retirement funds (also known as lifecycle funds) soared to 73 percent from just 11 percent in 2006.
“The PPA is proving to be one of the most significant legislative initiatives helping American workers save for retirement,” said James M. MacDonald, Fidelity's president of workplace investing. “While the PPA enabled sweeping reforms across workplace retirement savings plans for all workers, it has had the greatest impact on younger investors. The auto features have significantly boosted participation among younger workers and have simplified the investing process, giving them a solid start to investing for the future,” he noted.
The PPA, largely directed at improving funding requirements for defined benefit pension plans, included far-reaching reforms for 401(k) and other defined contribution plans as well, promoting the use of design features such as auto enrollment, default options and in-plan Roth deferrals.
Auto Enrollment Boosts Participation
The PPA provided employers with a safe harbor to default defined contribution plan participants automatically into “qualified default investment alternatives” (QDIA) if plan participants do not provide investment directions. Since 2006, Fidelity-administered plans that offer auto enrollment have grown to 21 percent, up from just 2 percent. Among the largest plans with more than 50,000 participants, 63 percent offered auto enrollment at the end of 2011.
Among Fidelity’s nearly 11.7 million 401(k) participants, about half (51 percent) are in plans offering auto enrollment, boosting participation rates:
• In plans with auto enrollment, the rate for eligible employees in plans jumps to 82 percent.
• In plans without auto enrollment, the average participation rate for eligible employees is 55 percent.
Auto enrollment is having a powerful effect on eligible employees ages 20 to 24, for whom the participation rate is 76 percent in plans with auto enrollment but only 20 percent in those plans without it.
Target-Date Funds Ensure Age-Based Allocation
The PPA and a U.S. Department of Labor final rule make target-date funds one of the permissible default investment options under the QDIA safe harbor. Target-date funds offer investors a diversified, professionally managed portfolio based on an projected year of retirement. In Fidelity-administered plans, nearly three quarters of plan sponsors use target-date funds as their default investment option, and 16 percent of total 401(k) assets are currently invested in them.
The use of these funds as default options has helped increase the portion of participants with an asset allocation within their age-based lifecycle band to 42 percent, up from 26 percent in 2006, according to Fidelity's analysis. This is most notable with Generation Y investors as 63 percent are within their age-based band.
Roth 401(k)s More Prevalent
Unlike traditional 401(k) plans where employees make pre-tax contributions and, after retirement, pay income taxes on all distributions, Roth 401(k) contributions are made with after-tax dollars. Funds in the plan grow tax-free and at retirement no taxes are owed on any distributions.
Launched in January 2006 on a trial basis that was set to "sunset," Roth 401(k) plans became a permanent retirement benefit option under the PPA, spurring adoption by plan sponsors. Since the end of 2006, plans offering Roth 401(k)s have grown to 31 percent from 4 percent, and nearly half of all participants in Fidelity-administered 401(k)s are in plans that offer a Roth feature.
Although use of Roth 401(k)s remains relatively low, it has doubled to approximately 6 percent, up from only 3 percent at the end of 2006, Fidelity found. Future growth of the Roth option is likely to increase, as Generation Y investors have adopted Roth 401(k)s enthusiastically, at 9 percent overall.
"The PPA provisions are most effective when bolstered by educational guidance, which can include on-site seminars, on-demand workshops, online tools and calculators, phone representatives dedicated to workplace plans and in-person consultations," advised Fidelity's MacDonald.
Auto Enrollment Boosts 401(k) Participation Among Minorities, SHRM Online Benefits Discipline, October 2011
401(k) Plans Add Features to Drive Participation and Savings, SHRM Online Benefits Discipline, September 2011
401(k) Participants Who Use Target-Date Funds Tend to Stick with Them, SHRM Online Benefits Discipline, September 2011
Balance Urged on Proposed Target-Date Fund Disclosures, SHRM Online Benefits Discipline, January 2011
The Roth 401(k): A 'Value Add' for Your Employees, SHRM Online Benefits Discipline, updated August 2010
Roth 401(k)s: Slow Start, but Welcome Where Tried, SHRM Online Benefits Discipline, updated December 2006
Stephen Miller, CEBS, is an online editor/manager for SHRM.
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