Automating the 401(k)

When the Pension Reform Act was passed a few months ago, it contained some lofty goals for encouraging employees to invest wisely within their 401(k) plans. Now Labor Secretary Elaine Chao has proposed specific rules to spur companies to get the ball rolling on this project.

Over the past 25 years, almost every major company has switched from a defined-benefit "pension" plan to a defined-contribution 401(k) plan -- named after the section of the tax code that created these plans. The change has caused problems that have worsened over the years.

Lack of Planning

Not long after the advent of 401(k) plans, it became apparent to observers that many younger workers saw little need to plan for the future; they were unaware that time was their most valuable asset. As the experts came to realize that a large number of baby boomers would have little besides Social Security to support them in retirement, campaigns were mounted to encourage increased contributions to retirement plans.

But then, those who did contribute were faced with another dilemma: How should they invest that money? Employers, fearing liability, were unwilling to provide advice beyond basic booklets discussing diversification. Plan participants followed the latest investing fad, or concentrated their money in company stock (used for matching purposes) or in "safe" investment alternatives that in most cases would not generate the growth necessary for retirement.

All that changes with the rules announced this week, which make it easier for fiduciaries -- those responsible for creating and implementing defined-benefit plans -- to adopt automatic-enrollment and investment-diversification features.