Many 401(k) plan sponsors have opted to periodically re-enroll all their participants into the qualified default investment alternative (QDIA) in their 401(k) plans. Doing so benefits 401(k) plan participants as well as plan sponsors. Here’s how:
1. Fixes poor investment selection at enrollment
Some participants spoke with aunts, uncles, brothers or sisters-in-law, spouses, dads or other “investment experts” when they set their investment elections at enrollment. As a result, some of their fund choices may not have been the best.
According to a JP Morgan study, 75 percent of participants are not confident about making investment elections. Re-enrolling participants into the appropriate target date option allows them to benefit from professional investment management and oversight of their account balance.
2. Appropriately diversified
One of the greatest concerns I have is for those retirement-eligible participants who have all or a majority of their account balance invested in one or a few funds (which are not target date or balanced funds).
It seems that there are always a few participants who end up investing too heavily in the wrong funds at the wrong time. Proper diversification is achieved when you re-enroll these participants into the appropriate target date option.
3. Rebalances participant accounts
Participants should rebalance their accounts back to their initial allocation percentages at least once per year. If this is not done, they could end up taking too much risk as their equity allocation increases over time, due to rising markets.
Many participants are not diligent about rebalancing their accounts. When was the last time you rebalanced yours? Target date fund managers adjust fixed-income and equity exposure as time goes by. This eliminates the need for participants to review and rebalance their accounts.
4. May reduce your fiduciary liability
It’s not uncommon to see lawsuits from participants who haven’t invested properly and end up at retirement with much less than they feel they need. Many of these lawsuits originate from participants who have concentrated their account balances in one or a few investment options and don’t have a balanced allocation.
These participants often allege that they weren’t given enough guidance or education by their employer to make better choices. They say that their employer did not meet its fiduciary obligation to inform and educate. Re-enrollment into target date funds washes that argument away.
5. Addresses changes in the fund lineup
Over time a 401(k)’s fund lineup changes. New funds are added and poor-performing funds are deleted. Participants who are not diligent about reviewing their allocations could end up with balances that are too-highly concentrated in a few funds or allocated into funds that they never selected (as a result of mapping).
6. Updates QDIA elections
Your plan may not have had a QDIA option until recently. As a result, some participants may have had their balances defaulted into pre-QDIA funds that are no longer appropriate.
7. Ensures age-appropriate investing
Many participants elected to allocate their contributions when they initially enrolled in the plan years ago. Unfortunately, they have not reviewed and adjusted their allocations as time has gone by. As a result, they may have contribution allocations or investment balance allocations that are too risky for their age.
On the other hand, there are participants in every 401(k) plan who don’t take enough risk with the investments they select to give them a shot at building an account balance big enough to fund their retirement. These participants often elect a more conservative path because they don’t understand investing or are afraid of taking risk.
The JP Morgan study showed that 88 percent of participants have the wrong level of equity exposure for their age. Re-enrollment in target date funds results in an appropriate level of risk taking for a participant’s age.
If you have never re-enrolled all your participants into your QDIA default funds, seriously consider doing so this year. Keep in mind that with any re-enrollment, participants can opt-out by choosing their own investment mix. However, studies have shown that more than 80% choose to remain in the funds that their balances are allocated into.
Re-enrollment is another way of using participant inertia to their advantage and can be an important strategy in helping participants achieve retirement readiness. According to JP Morgan, 82 percent of participants support re-enrollment.
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton is an award-winning 401(k) investment adviser with over 30 years of experience. He has consulted with many Fortune 500 companies, including: Aon Hewitt, Apple, AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Corporation, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or bob@lawtonrpc.com.
