Storm Clouds Ahead for 401(k) Plans?

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No. 22 in the Retirement Policy Program series of briefs.

Abstract

Designed to promote retirement saving, the Pension Protection Act of 2006 clarified auto-enrollment, auto-contribution, and auto-investment rules in employer 401(k) plans. Early evidence suggests that the legislation boosted these plan features and increased employee participation in 401(k) plans. It is too soon to gauge the act's ultimate success, however, because it hinges on the number of new participants that will eventually amass substantial account balances. Adding to the uncertainty, the recent LaRue Supreme Court decision, which highlights the legal liability that employers face as plan fiduciaries, could undermine future retirement security by making some employers reluctant to sponsor plans.

Introduction

In 2006, Congress acted decisively to put the nation's retirement saving system on a smoother glide path to success. The Pension Protection Act of 2006 (PPA) blessed three design innovations to make 401(k) and other workplace saving plans more productive.1 First, employers can sign up workers into saving by payroll deduction ("autoenrollment"). Second, employers can choose how much, as a percentage of pay, workers will save and can automatically increase it ("autocontribution") for each year on the job. Third, employers can invest workers' accounts in a designated default fund ("auto-investment"). Workers can always choose not to save, choose a different amount to save, or choose alternative investment options. PPA also includes legal protections for employers who include these features in their plans.

These "auto-pilot" provisions were intended to change two of the most intractable problems facing the 401(k) plan system. The first is low savings rates by workers, especially low- and moderate-income workers. The automatic features are intended to give workers a plan that makes saving easy and rewarding by requiring few up-front choices. The second is low plan sponsorship rates by employers, especially small and medium-sized employers. The hope is that employers will be more willing to offer a plan if it is an auto-pilot plan with less legal liability.

Are PPA's reforms taking hold? Early results indicate some encouraging signs nearly two years later. Will they succeed over the long run? Most indications are positive. Arecent Supreme Court decision in LaRue v. DeWolff, Boberg & Associates, however, has clouded the legal landscape for 401(k) plans so recently cleared by PPA. This case, which clarifies the rights of plan participants to sue, threatens to thwart PPA's effort to entice more employers into offering plans.

(End of excerpt. The entire brief is available in PDF format.)

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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