On August 4^th, 2006, Congress approved a heavily debated bill that could have an effect on not only pensions but also how your 401(k) and similar self directed retirement plans work. While it is too early to tell exactly how this will impact the average worker, I can give you some of the basics of these changes and how you can be diligent when they eventually take place. Most of the changes, it should be noted are not scheduled to take effect until 2008.

The move from defined benefit plans to defined contribution plans changed the retirement landscape when they were first adopted over three decades ago. The flaw in the plan, as many of us found out rather quickly, created a situation that put many people at risk of not investing in the right mix of investments and worse, allowed some people who needed it most, to simply sit back and do nothing. 

The company had little more to do that provide the opportunity and sometimes, although this sentiment has waned in recent years, a match for employee contributions. Employees were left to sift through the choices and determine where to direct their money. Few knew the basics of investing. Even fewer knew how much risk their choices had or whether they were prudent places to direct their retirements.

As a result, far too many investors simply did nothing. Although there was a plethora of financial education offered from risk assessment to the lessons learned from Enron employees, the plans languished in a nether world of half hearted investments or worse, low risk alternatives to growth. 

We prodded and pleaded with workers to take charge of these plans. We used fear. We painted a bleak picture of the future. We mostly failed with only half of the workers eligible to participate actually doing so.

Congress viewed this as an evil inertia, a state of non-investment that Wall Street worried about enough to lobby for change. Inertia by the way is Isaac Newton’s First Law of Motion and states that a body will remain at rest or in motion until a force changes its direction or compels it to move. Congress with the help of Wall Street seeks to be that force. That may prove to be unfortunate.

While actual statistics vary on the exact number of investors on the sidelines or under-invested, the bill will change these plans and the role your company has in administering them significantly. 

It will take several years for the plans to evolve into the new structure, which will give you time to get your own house in order before your company with the assistance of a truckload of financial advice from Wall Street steps begins to implement the bill. But when that change does happen, the current participants may be the ones most deeply impacted. Here, in a nutshell, is what will happen to the plans of those who are not currently enrolled or have taken the default investment.

401(k) plans and similar self-directed plans will no longer be completely self-directed. This is an enormous change in philosophy giving your employer the right to step in and direct the plan without your approval. If the company deems that your plan is not growing at an acceptable rate because you are underinvested in money market accounts or are not invested at all, the company can change your plan. Doing so on your behalf, if you fall into one of the categories I just mentioned, will be a considerable improvement over the way these plans are introduced to newly hired workers. Legislation was not needed to change this lack of interest. The fiduciary responsibility of helping employees achieve a retirement goal was supposed to begin with the employer in conjunction with the plan. Failure to do so should have resulted in penalties not legislation.

When these plans were first introduced, they provided an important shift in roles, one employers were all to happy to shed as they turned away from pensions (which they had control over) to 401(k) plans (which they did not). The idea behind this Congressional bill attempts to help the less-than-savvy employee by taking their misdirected money and putting it into higher risk stock and bond funds or a diverse mix of funds designed to provide additional growth. While millions of words have been dispersed over the years helping folks determine risk, this bill gives your employer the omnipotent role of determining that difficult to pinpoint factor. Can they do what so many have failed to do?

The bill will also allow the employer to make increases in contributions on your behalf. The bill does not actually require such actions but the incentive to allow for minimum step-ups such as 3% one year, 4% the next, and up to 6% in subsequent years seems on the surface to be a good thing. There is no requirement for employers to match “step-up” increases with their own funds. Could this be the new wage increase?

Automatic enrollment for new employees also seems to be a positive move in the right direction. Employees will be enrolled in the plan although the waiting period for eligibility will not change in many cases.

And lastly, Wall Street will be there with advice. Opponents of the bill harbor a realistic fear that the advice would not be completely trustworthy. The investment community convinced Congress that they would be, keeping the clients best interest at heart and promising to direct them to the best investment. The worry was based on the possibility that these “advisers” would direct investors without much savvy to investments that might better serve their firms profit margins and not their “client’s best interests”. Really?

The best investor is a skeptical one. Free lunches like free advice are often not free or very satisfying. Even if the changes the legislation brings actually helps workers who may not have invested or done so with any success do better, your best path will always be the one you choose. It is the one you feel most comfortable taking because you have educated yourself on the possibilities and potential.

You are the reason Wall Street exists. Stay in control of that situation which is something you can do without Congressional assistance. If you do you will be a better investor. 

© 2006 Paul Petillo
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Paul Petillo
Blue Collar Dollar.com
Portland, OR USA
(501) 313-5252
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