7 hot 401(k) trends

By Liz Pulliam Weston

In the beginning, safety features weren't a standard part of automobile design. It took decades for car manufacturers to introduce things like seat belts, collapsible steering columns and crush zones on mass-produced vehicles.

Likewise, 401(k) plans weren't originally designed to save investors from themselves -- or from run-ins with greedy plan administrators or a malfunctioning marketplace. But a couple of decades of experience in seeing how workers go wrong with their plans is altering how workplace retirement plans function.

Many of the features are designed to fix some of the most common 401(k) blunders, such as not signing up, taking too much or too little risk, and cashing out early. Others were a backlash against high fees and scandals in the mutual-fund industry. The last -- the so-called Roth 401(k) -- is an intriguing twist that may be coming to a 401(k) plan near you … someday.

Here are the trends, the caveats and the suggestions for what your game plan should be:.

Making retirement saving automatic

About 25% of eligible workers fail to sign up for available 401(k) plans, a fact that frustrates company executives in two ways:

• Nonparticipants are shortchanging themselves and their futures, leaving free money -- company matches -- on the table and increase the chances they won't have enough money to retire comfortably.

• Low participation among rank-and-file workers can limit how much higher-paid workers are allowed to contribute to their retirement funds, thanks to IRS rules that govern how 401(k)s work.

A growing number of companies have decided to harness workers' inertia by making 401(k) enrollment automatic: Employees have to opt out if they don't want to participate.

The typical plan starts the automated contribution at 3%, and some increase the deduction by 1% every year. Employers that have tried the option say it boosts participation to more than 90%, said Ed Ferrigno, vice president of Washington affairs for the Profit Sharing/401(k) Council of America, a trade group.

That means, of course, that participating companies are shelling out more in matches, something not all companies are willing to do.

Automatic enrollment plans "are so successful at increasing participation that you have to come up with money for a lot more people," Ferrigno noted. "It's the true believers who are doing this."

About 35% of large-company employers (median workforce: 10,000 employees) have put their plans on automatic, according to Hewitt Associates' 2007 survey of retirement trends, nearly double that of two years ago. Another 35% of companies said they were very likely to automate enrollment for new hires by the end of the year.

The default investment option for those automatically enrolled is improving, with half of plans using "target maturity" funds, which make investments geared to a worker's planned retirement date. Companies used to place new hires in extremely conservative investment options, typically money markets and stable value funds; 17% still do. (A diversified default investment is one condition required by federal regulation, effective in December 2007, for companies wanting to avoid liability for losses -- so look for this trend to continue.)

"Automatic rebalancing" is another feature designed to reduce retirement-savings hassles. Offered by 42% of large employers, this option allows participants to select a portfolio of mutual funds that is then rejiggered as often as every quarter to return it to the original asset weightings.

The caveat: A 3% contribution rate isn't high enough to ensure a comfortable retirement, yet only 13% of the companies that enroll workers automatically also offer "automatic escalation" to increase contribution rates over time. Another 22% offer it as an option.

Also, auto-rebalancing can be a great idea, but participants still need to review their asset weightings occasionally to ensure they still make sense. In particular, it's usually wise for participants to reduce their exposure to stocks as they approach retirement.

Your game plan: If you're one of those high-paid workers whose ability to contribute is being restricted by your nonparticipating colleagues, urge your employer to consider this option. If you're one of the employees who has been signed up automatically, make sure you're invested to take advantage of long-term growth. Also, elect automatic escalation if you can, or consider boosting your contributions each year until you're contributing the maximum allowed. If you use an auto-rebalance feature, make sure you revisit your asset-allocation strategy at least every few years and make any necessary tweaks.

Simplifying your investment choices

When the stock market was hopping in the late 1990s, giving workers more investment choices was all the rage. Some companies introduced dozens of new options and a few even offered "brokerage windows," which let employees invest their 401(k) money in an almost unlimited array of funds and individual stocks.

Hard-core investing buffs loved having all the choices -- and promptly drove up plan costs with frequent trading. Many workers, though, looked at all the options and just froze.

Although employers aren't necessarily disassembling their complicated plans, the average number of available options is now at 17, and 75% of the companies Hewitt surveyed offer life-cycle or target-maturity funds. In general, these funds automatically rebalance investments and gradually reduce exposure to stocks as the employee approaches retirement.

"It's really a sea change from where we were as an industry in the 1990s," when plan sponsors piled on the options, said Lori Lucas, Hewitt's director of participant services. Automatic investing options like life-cycle and target-maturity funds "are much easier for participants to use."

The caveat: Unfortunately, many workers still don't quite get the all-in-one nature of a life-cycle fund. They may select it as an investment option but then contribute to a number of other options as well, which undoes much of the benefit. And some of the target funds get a little too conservative at the end.

Your game plan: If you're tired of messing with your 401(k), use the life-cycle, target-maturity or automatic-rebalancing options if your company offers them; if not, ask if they can be added. Or just invest in the balanced-fund option you're probably offered -- the 60% stock and 40% fixed-income mix is often a good default option, and it's automatically rebalanced without any effort on your part.

Red-flagging company stock

The temptation to overdose on your own company's stock can be strong. Familiarity breeds comfort. Many 401(k) investors think (wrongly) that their own companies' shares are safer than a diversified mutual fund.

The dangers of such thinking have been made abundantly clear by several high-profile corporate bankruptcies. The most notorious was Enron, where company shares made up about 60% of workers' 401(k) assets. Its bankruptcy simultaneously wiped out the jobs and retirement plans of thousands of employees.

Many companies have responded by removing their own shares as an investment option, and 17%of the companies that offer their own shares restrict how much participants can buy.

The caveat: When shares are available, employees are still inclined to overindulge. In plans that offer company stock, 1 in 3 workers invests more than 20% of their balances in such shares.

Your game plan: No one company, including your own, should make up more than 10% of your retirement portfolio. If your company makes its matching contributions in its own shares, as nearly a quarter do, you may already be exceeding that limit. If so, take advantage of any opportunities you're given to sell off those shares and reduce your exposure.

Containing the fees

The mutual-fund scandal, in which major fund providers were accused of helping a handful of favored investors profit at the expense of millions of others, finally prompted some employers to get serious about the fees they and their workers are being charged for 401(k) accounts, Ferrigno said.

Continued: Stemming cash-outs

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