What’s the Pension Protection Act Done for 401(k)s?

The PPA turns 10. How is it affecting 401(K)s?
The PPA turns 10. How is it affecting 401(K)s?

Ten years on and what have we got to show for it? Quite a lot, according to Vanguard. The investment behemoth marks the 10th anniversary of the Pension Protection Act of 2006 (PPA) by releasing a special 15th anniversary edition of its How America Saves report.

“The Pension Protection Act codified many of the ‘auto pilot’ features that Vanguard and others in the industry had been advocating for in retirement plans for years,” said Martha King, managing director of Vanguard’s Institutional Investor Group. “The improvements brought on by the industry, amplified by the PPA, has continued to bolster our defined contribution system and cements our view that 401(k) plans are a critical component to helping ensure the retirement security of millions of Americans.”

Maximizing participation and boosting savings rates
Among its provisions, the PPA enabled the automatic enrollment of workers into 401(k) plans at a default savings contribution rate, as well as the auto escalation of workers’ contribution rates on a periodic basis. As of year-end 2015, 41 percent of Vanguard plans had adopted automatic enrollment, up from just 10 percent of plans a decade ago. Of those plans, 70 percent featured automatic annual increases. Last year, 63 percent of new Vanguard participants were hired under automatic enrollment, versus 12 percent in 2006.

Vanguard research has shown that automatic enrollment can more than double participation rates in comparison to voluntary enrollment plans. This trend is particularly evident among young or low-wage workers, who tend to exhibit lower savings behaviors. In large part due to autopilot design features, aggregate participation rates are higher than ever and continue to rise. In 2015, three-quarters of eligible employees participated in their employer’s plan, up from two-thirds ten years ago.

Driving prudent investments
The PPA also sanctioned the use of target-date funds as a qualified default investment alternative. Vanguard researchers have long espoused the merits of target-date funds and other professionally managed options, maintaining that they can result in more prudent and risk appropriate participant portfolios.

Target-date fund use has nearly doubled since the passage of the PPA, with 90 percent Vanguard plan sponsors offering target-date funds at year end 2015. In aggregate, 98 percent of participants now have access and 70 percent of participants use target-date funds.

“Target-date funds are, without question, a game changer and one of the most important elements of the 401(k) evolution,” said Jean Young, lead author of How America Saves. “As defined contribution plans evolved, it was clear that many workers were not going to serve as their own investment manager. As a result of the rise of target-date funds, we’ve seen dramatic improvements in the portfolio construction of 401(k) participants.”

There’s work to be done
Looking ahead to the next decade of the post-PPA era, How America Saves data points to key areas needing improvement. In particular, the rise of automatic enrollment has had an inverse effect on deferral rates. Nearly three-quarters of plans default at participant at savings rates of 4 percent or less. Automatic enrollment boosts participation rates, but it can lead to lower contribution rates when default deferral rates are set at insufficient levels. In contrast, Vanguard recommends a target savings rate of 12 percent to 15 percent, including an employer match.

“Plan sponsors—and the industry as a whole—must bear the responsibility to continue the significant progress impelled by the PPA, including driving improved savings rates for all participants,” said King. “Moreover, the 401(k) system needs to cast a wider net to afford the opportunity for more Americans to prepare financially for retirement and capitalize on the advantages of these plans.”

John Sullivan

With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.

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