The 401(k) provisions alone may bring in more than $1.8trn (€1.42trn) in new savings over the next 20 years because more people are likely to make use of such accounts, according to Financial Engines, a Palo Alto, California-based investment adviser to companies. But the new Pension Protection Act of 2006 (PPA), signed in August by President Bush, will have a profound impact not only on the size of the defined contribution (DC) plans, which already have 47m members and contain $3.3trn in assets, more than one third of all money managed by the mutual fund industry. It will also change their design, encouraging automatic enrolment and different default funds, raising the tax deductible savings, and allowing financial advice.
On the other hand it won't stop the gradual fading of defined benefit(DB) plans, which declined from 112,000 in 1985 to 30,000 in 2004 and now cover 44m Americans. Maybe the new funding rules will strengthen their financial situation, but they won't make them more appealing for employers. On the contrary, the PPA has declared perfectly legal DB pension funds' transformation into cash-balance plans.
Not surprisingly the whole financial industry applauded the reform and key players like Fidelity, the largest provider of 401(k) plans, immediately announced new features for their services. "Employers expect mutual fund firms and others to set up a raft of new vehicles to handle the rush of new money from employees", said David Wray , president of the Profit Sharing/401(k) Council of America, which represents large retirement plan operators. The group estimates an extra 10m people will join 401(k) plans in coming years, thanks to the automatic enrolment provision. So far only 19% of US businesses automatically have been enrolling employees in 401(k)s because of laws in 31 states banning paycheck deductions without employee consent, according to a June 2005 study by the consulting company Hewitt Associates. The new bill overrides these laws and allows companies with 401(k) plans to automatically enrol employees unless the worker opts out. The Investment Company Institute, which represents the mutual fund industry, estimates participation in 401(k) plans at businesses that offer them would rise to 92% from 66% today because of the automatic enrolment provision.
"The bill is focused on getting people to participate in their 401(k) plans," said David Liebrock, executive vice president of Fidelity Investments Institutional Services Co. The Boston mutual fund giant said it will add an automatic-enrolment service, it will make available a group of retirement consultants to employers who have these plans and it will offer employees in 401(k) plans use of a free annual review of their retirement savings.
Financial advice is another hot topic related to the reform: it will mean a boom in fees for the advisory companies, said Jim Lowell, editor of the independent trade newsletter Fidelity Investor. The 401(k) advice business currently generates about $200m annually in fees from the company sponsors of plans, he said. That may increase by as much as $1bn.
The provision sparked controversy because it allows plan providers to also provide advice, an example of conflict of interest according to critics who saw potential for companies to advise buying their own products, whether or not they were appropriate for the investor. Among the strongest critics there is the Financial Planning Association (FPA), the nation's largest trade group representing planners, which is not happy even with the bill's requirement that advisers act as "fiduciaries". "Even if this whole new population of so-called fiduciary advisers does comply with the admonitions, they are certainly going to be given a new opportunity to cross-sell other products," Neil Simon, the FPA's director of government relations, said. FPA would have preferred a rule to encourage employers to hire independent advisers.
Last but not least, the PPA makes it easier for companies to use mutual funds, including life-cycle and target-date funds, as the default options for employees. "The biggest change has been marrying auto-enrolment as the default option with an age-based retirement fund or a retirement-date fund," says Charles Vieth, president of T Rowe Price retirement plan services.
"Our concern was that participants thought they were on track to save for a secure retirement, but default options (like money market accounts) didn't guarantee that."
Vieth added that more than half of T Rowe's clients that offer auto-enrollment now default employees into a retirement-date fund, rather than into a stable value or money market account.