Attention 401(k) slackers!

By Janet Novack

updated 6:00 p.m. ET Oct. 2, 2006

WASHINGTON - If you've had trouble deciding what to do with your 401(k) savings — or even whether to save — your employer may be about to make that decision for you. And it might not be a bad decision.

Last month, the Department of Labor proposed "safe harbor" regulations that would allow employers to adopt certain default investments for indecisive workers without worrying that they'll be held liable if those investments go sour.

In the past, employers fearing liability have typically used low-return money market funds as their default, notes U.S. Secretary of Labor Elaine L. Chao. That's hardly a good choice for a long-term investment.

Under the proposed rules, which should be final by next February, employers can choose from three types of safe harbor defaults: life-cycle funds, where investments vary according to a worker's age or expected retirement date; balanced stock-bond funds not related to a worker's age; and professionally managed accounts, which typically rely on computer models that take into account an employee's age and other factors.

The new investment rules were mandated by the pension overhaul signed into law in August. They are part of a larger effort in the law to make participation in 401(k) more automatic — just as participation in the now-disappearing defined benefit employer-funded pensions was.

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Under the new law, employers can actually contribute a slightly lower match to each worker's 401(k) without having to pass complicated "nondiscrimination" tests, provided they automatically enroll workers — meaning employees have to opt out of, rather than opt into, a plan. In a typical opt-in plan, 28 percent of employees don't elect to participate; with automatic enrollment, only 8 percent go to the trouble of actively electing to pull out of it, says Jack VanDerhei, a Temple University professor and fellow at the Employee Benefits Research Institute.

Under the proposed safe harbor, employers will still be responsible for picking funds or managers with reasonable fees and track records. But they're not liable for the actual performance of the funds if they've exercised — and continue to exercise — due diligence.

"The employer is still on the hook for looking over the provider's shoulder on an ongoing basis to make sure the provider hasn't jacked up fees or changed management in a way that gives the employer heartburn," observes benefits lawyer J. Mark Iwry, senior adviser to the Retirement Security Project and a Brookings Institution fellow. The proposed rules, he adds, "are a good step forward."

The new safe harbor investment options could have a big effect on plan balances, particularly for lower-income workers, who are more likely to simply rely on the defaults — 38 percent of those earning $32,000 or less do so, versus just 19 percent of those earning $53,000 or more, according to EBRI.

The rules should also give a boost to the use of managed accounts, such as those offered by Financial Engines, the pioneering Web-investment advice software company. Financial Engines Chief Investment Officer Christopher Jones says his company has so far signed deals to offer managed accounts to 2 million workers, including those at Motorola and JC Penney.

When employees are offered the managed account on an opt-in basis, 15 percent to 20 percent take it; when they are required to opt out— in other words, when it becomes the default option— 60 percent to 70 percent stick with the service, he notes. (The management fee runs from 35 to 60 basis points, with large accounts and those signed up through an opt-out program paying the lower fees in that range.)

The managed accounts, Jones says, appeal to a completely different group of employees than Financial Engines' do-it-yourself Web software. (The do-it-yourselfers tend to have higher incomes, for example.)

The proposed rules, he says, reflect "a shift in the mindset. Ten years ago, it was, 'How do we educate people to change their behavior?' And now it’s, 'How can we change the way the plans are designed to recognize the fact that most people don't want to do this for themselves?'"

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