Navigating the 401(k) Labyrinth

The changes authorized in the Pension Protection Act -- as well as still-evolving regulatory changes -- create communication challenges for HR leaders. Employers can start the communication process by asking themselves a few key questions.

Tuesday, January 2, 2007
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In order to help defined-contribution plan participants achieve their retirement investment goals, the Pension Protection Act encourages employers to automatically enroll their employees in the company's DC plan, provide default investment options and make investment advice available to plan participants.

Employees benefit from more information, enhanced notification and disclosure requirements, increased diversification rights and access to professional investment advice. Employers benefit by helping their employees save for retirement while potentially narrowing corporate liability in certain areas where prescribed conditions are satisfied.

These changes reinforce the importance of establishing effective communication between employers and employees about plan benefits and requirements even as the Department of Labor, U. S. Treasury and IRS are only just now beginning to translate the PPA into administrative regulations.

As federal guidance evolves, both employers and employees will face important decisions.

Plan participants will need to understand their new investment powers and how the emerging choices available to them can help achieve a stable, secure retirement. Plan sponsors will need to decide how to deliver benefits to participants and determine what changes in documents and procedures need to be made under the new regulatory regime. These choices will help shape the communication strategy with employees. Publications like Milliman's Client Action Bulletin, which review requirements as they emerge, may be useful tools in this process.

Employers can start the communication process by asking themselves a few key questions. As the regulatory landscape becomes more distinct, their answers can form the content of a timely, thoughtful employee communication effort.

Do we implement automatic enrollment?

Automatic enrollment arrangements have been used by employers since the IRS first issued guidance in support of them several years ago. Some employers have been unwilling to offer the option, however, out of concern that certain issues -- the choice of a default investment, the application of state wage-withholding laws and the distribution of elective deferrals -- could create employer liability or adverse tax consequences even if the participant did not receive or ignored the communications about the automatic enrollment program.

The PPA addresses these issues by preempting state wage-withholding laws in certain instances, directing the DOL to provide guidance on default investments that relieve employers from certain fiduciary obligations and permitting the distribution of employee contributions if an appropriate election is made within 90 days of the first payroll deduction. Although the PPA does not require auto-enrollment, it offers it as an option for employers to encourage participation of more employees in their DC plans.

It is impossible to adequately address the topic of auto-enrollment in the space allocated for this article. Suffice it to say that the auto-enrollment, default investment and "safe harbor" provisions pose both implementation and communication challenges for HR executives that can best be dealt with by examining how these plan features fit with their organization.

As they and their consultants begin to explore their unique situation, they will encounter many questions: Do we take advantage of the nondiscrimination-testing safe-harbor plan design that is outlined in the PPA? If we implement the auto-enrollment safe harbor, do we shepherd current employees into the plan, or focus only on new employees? How do we take advantage of the state pre-emption standard?

And, perhaps most important, how do we ensure that employees are informed of our decisions before, during and after we implement the changes?

Do we institute automatic contribution increases?

Under the PPA, employers are not required to increase employee contributions, unless the plan sponsor chooses the nondiscrimination-testing safe-harbor plan, in which case, certain minimum employee contribution levels apply.

From a communications standpoint, this raises additional challenges. Employers who implement the minimal employee contribution with annual increases will want to remind their employees of this increase each year. Employers also need to consider that automatic contribution increases may push some employees out of the plan altogether.

How do we choose a default option for the employee's investments if the employee doesn't select one?

Under the PPA, employers will be able to reduce their fiduciary liability when they select a default investment option that complies with forthcoming DOL guidance. Default investment options arise in a number of circumstances, including plans with automatic enrollment and rollover contributions, where employees fail to make investment choices.

Because the focus of the provision is to ensure long-term growth of retirement funds, the most likely type of "default" option to be approved by DOL will include "lifecycle" or "targeted retirement date" mutual funds, where investments seek to maximize return based on the individual's retirement date.

The notice requirements associated with the proposed regulations on default investment options are outlined in Milliman's Nov. 15, 2006, Client Action Bulletin. Many plan sponsors who have pre-PPA "default" investment options have chosen a more conservative "stable value fund" approach to limit losses and avoid liability.

Under the PPA, these plan sponsors will need to review the final guidance when it is published and communicate the changes in any default investment options that they implement.

Are we prepared to comply with emerging diversification requirements?

The PPA also enacted notice and disclosure requirements to protect employees. Additionally, participants are provided enhanced rights with respect to their retirement plan investments.

For example, the diversification requirement that generally becomes effective in 2007 requires DC plans holding publicly traded employer securities to allow participants to diversify both the employee and employer contributions invested in employer securities.

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The plan must notify participants of their right to divest employer securities at least 30 days before they are eligible to exercise their diversification rights. The IRS has also extended the transitional period for implementing necessary changes.

Should we provide investment advice?

Under the PPA, plan sponsors can provide participants with a "fiduciary adviser" who will be able to offer individualized investment advice beyond the previously permitted general or educational information about asset allocation, plan options, and the like. The plan sponsor chooses a fiduciary adviser service provider who must meet certain fiduciary standards. The fiduciary adviser may be paid either by the employer or from plan assets. In turn, the PPA relieves the plan sponsor of certain fiduciary liabilities under certain conditions.

Investment advice can be delivered in one of two ways:

* Via certified software programs that allocate assets based on the investment options in the DC plan. Fees can vary, depending on the computer model and work involved.

* Through a fee-for-service fiduciary adviser who is paid to advise on investment choices rather than to sell specific investment products (since this would violate the fiduciary requirement to act in the best interest of the participant).

The communication process is further complicated if the plan involves default investment options. Employers should begin to consider how they are going to implement these provisions -- and how the provisions affect their communication strategy -- even as many of the regulatory requirements are still being fashioned. Well-informed plan participants will understand how investment advice is generated, how it is paid for, and what their responsibilities are in the investment process.


DC plans are becoming the dominant vehicle for employer-based retirement programs. Plan sponsors who take advantage of the provisions of the PPA can both enhance plan participation and limit plan liabilities. Their efforts will succeed if they also fashion an effective communication strategy that recognizes three requirements:

* Employees need to understand that they are responsible for implementing the long-term investment strategies that secure their retirements;

* Employers must recognize that DC plans succeed in reaching that goal when more employees participate; and

* Employers must acknowledge that the evolving regulatory regime of the PPA makes effective communication of DC features, actions and opportunities more important than ever.

With more than 900 qualified consultants and actuaries, Milliman provides employee benefits, healthcare, and insurance consulting services to clients worldwide. Nancy Nourse, a certified employee benefit specialist, is a benefits communication consultant with in the Seattle office of Milliman. She can be reached at (206) 624-7940 or at Rhonda Migdail, an attorney, is the director of Milliman's Employee Benefits Research Group, based in Washington. She can be reached at (202) 292-1199 or at

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