Pension reform gives 401(k) an upgrade

The 401(k) is transforming.

The pension reform bill that President Bush signed into law makes 401(k)s friendlier to workers and encourages employers to help savings-challenged Americans build their nest eggs for retirement.

The most potent change is the provision that smoothes the way for employers to automatically enroll workers in 401(k) plans, bump up their contributions over the years, and put them in suitably aggressive investments to meet their retirement needs.

As much as the 401(k) is changing, workers need to change the way they think about it.

The 401(k) was invented in the 1980s as a supplement to company pension plans. The new law — in its realization that corporate pension plans are distressed and dying, and its efforts to make 401(k)s more automatic and universal — in effect anoints the 401(k) as America’s new primary retirement plan.

The message to workers is, if you haven’t been paying attention to your 401(k), you need to start.

Personal finance experts praise the law because, they say, many Americans are doing a lousy job saving for retirement on their own.

“The 401(k) has been based on the fact that individuals will do it themselves,” said Christopher Jones, chief investment officer at Financial Engines Inc., an investment advisory firm. “That fundamental assumption is false for a majority of the population. If people are not willing or able to make informed choices by themselves, what are they going to do?”

The problem is clarified by Fidelity Investments’ annual report on the state of 401(k) investing, which came out recently.

The average 401(k) account balance increased to $62,500 last year, up 3 percent from 2004, the giant mutual fund firm reported. At the same time, only 64 percent of eligible employees opted to participate in 401(k)s, a decline of 1 percentage point from 2004.

Automatic enrollment programs will “substantially boost” the rate of participation to as high as 95 percent, with particularly dramatic increases for lower-income workers, minorities and women, according to the Retirement Security Project, a partnership of the Brookings Institution, a liberal-leaning think tank, and Georgetown University.

“We estimate that automatic enrollment, when fully phased in, could generate $10 billion to $15 billion of additional contributions to 401(k) plans each year,” said Peter Orszag, director of the Retirement Security Project. “Those additional contributions will bolster retirement security for millions of workers.”

Many companies had been holding off establishing automatic enrollment because of legal uncertainties. Companies feared that if workers were automatically enrolled in suitably aggressive investments, and the stock market tanked, the workers could sue.

In many ways, the pension reform law gives more momentum to a trend that’s been in the works at many companies.