Personal Finance

Don't fear a 401(k) re-enrollment notice, it's a good thing

Key Points
  • A study shows 22.4 percent of companies have done a re-enrollment, up from 8 percent in 2012.
  • The process puts participants into the default option unless they direct otherwise.
  • Benefit can be a better-allocated portfolio.

If you receive notice that you're being re-enrolled in your 401(k) plan, rest assured it's probably a good thing.

A growing number of companies is using a so-called re-enrollment feature, which basically involves telling participants that their retirement savings are being moved into a default investment option unless they choose other funds in the plan's lineup, or reaffirm a previous choice.

Recent survey data from investment consultancy Callan Associates of San Francisco show that 22.4 percent of 401(k) plans have now gone through the process, compared with 8 percent in 2012.

The reasons for doing it vary. Yet the end result is typically the same: Workers' assets end up in a better-allocated investment portfolio.

Jamie Grill | Getty Images

"I'm supportive of this," said certified financial planner Hans "John" Scheil, CEO and owner of Cardinal Retirement Planning in Cary, North Carolina. "The reality is that most people don't have their 401(k)s properly allocated. And most don't ever reassess where they stand."

Most companies (62.1 percent) in the Callan study have done a re-enrollment when the fund lineup changes. Some companies (27.6 percent) also might use the process to address user errors every few years or so. That is, the advisor to the fund might discover that participants' portfolios are full of poor investment choices. In that case, the process will result in those workers having a better-allocated default option or, at the very least, prod them to evaluate their previous choices.

In simple terms, the way your portfolio is allocated should be a reflection of your risk tolerance (how well you stomach market volatility) and your risk horizon (how long until you plan to use the money).

Although a retirement saver initially might consider those factors and arrive at, say, a mix of 90 percent stocks and 10 percent bonds and cash, over time that allocation can get out of whack if one category begins taking over more of your portfolio than intended.

Even within those two broad asset classes, as not all investments necessarily move in lockstep, your portfolio's makeup can eventually no longer resemble your original strategy.

In addition, as time passes, an allocation that worked when you were in your 30s might no longer be appropriate as you near retirement.

Improving your 401(k)

In many 401(k) plans, target-date funds are now the default option. This means that when employees enroll or re-enroll in the plan and don't actively pick investments, their money will end up in those funds.

Sometimes considered a set-it-and-forget-it investment, target-date funds automatically shift their assets to more conservative investments as you approach the planned year of retirement. In other words, your allocation is determined for you.

"I'm not a huge fan of target-date funds because they treat everyone the same," said CFP Mike Keeler, CEO of Peak Financial Solutions in Las Vegas. "But it's better than nothing, and it's a simple way to get employees invested."

The Callan study shows that 88.2 percent of plans use a target-date fund as their default investment. Part of the reason is that federal law offers some relief — a "safe harbor" — when plan sponsors use them as the default option. While not absolving companies of their obligation to work in the best interest of participants as overseers of their accounts, it does offer some legal protection.

* Multiple responses were allowed.

"The primary motivation is to improve participant investing," said Fred Reish, a partner in the Los Angeles office of Philadelphia law firm Drinker Biddle & Reath. "But the safe harbor helps, because it takes away the feeling of risk."

Reish also said that if companies choose to use re-enrollment periodically, it shouldn't be done more often than every two or three years.

That allows "enough time so that individual circumstance might have changed from the last time," Reish said.