In 2006, Congress passed the Pension Protection Act. Can leaders do it again?
At times, it seems like nothing much good comes from the policymakers in Washington, D.C. Efforts to rein in long-term entitlement spending have mostly foundered. In recent years, plans to expand access to workplace retirement plans have gone nowhere. In the current environment in Washington, D.C., even a task as simple as raising the debt ceiling— to pay for appropriations that Congress has already approved—has proved difficult, with the country coming to the brink of default on numerous occasions.
But it is worth remembering that the federal government sometimes gets things right. We have reached the 10-year anniversary of one of the largest achievements in recent policymaking, the Pension Protection Act of 2006 (hereafter referred to as the PPA). Thanks to its provisions relating to 401(k) accounts, the PPA will ultimately help tens of millions of Americans achieve better-funded retirements.
What Is the PPA, Anyway?
Much of the PPA focused on shoring up financially troubled defined-benefit plans— and especially their insurer, the Pension Benefit Guaranty Corp., or PBGC—but the legislation also had incredibly important provisions relating to defined-contribution plans, including 401(k)s.
Broadly speaking, the PPA was probably the first major piece of legislation that relied heavily on learnings from behavioral economics, according to Doug Fisher, a senior vice president of Thought Leadership and Policy Development at Fidelity. Behavioral economists focus on providing the right “choice architecture,” or more colloquially, making it easier for people to make the right decisions. In short, in three key areas the PPA relied upon a human tendency toward inertia to help them achieve better retirement outcomes.
First, the PPA strongly encouraged the use of auto-enrollment by plan sponsors. Companies with 401(k)s typically need to conduct “fairness testing,” which is designed to ensure that the benefits of a defined-contribution plan do not flow disproportionately to upper-income employees. This testing can be cumbersome, and in certain circumstances, it can lead to the loss of certain tax benefits for 401(k) plans. With respect to fairness testing, the PPA established a “safe harbor” for sponsors that auto-enroll their employees, provide matching or unilateral retirement contributions, and meet a number of other criteria.
Second, the PPA promoted plan sponsors’ use of auto-escalation features in their plans. Again, the legislation provided a safe harbor for those employers who meet certain criteria, including auto-escalation. Academic research shows that a lot of people know they need to save more for retirement and plan to do so in the future— and yet never get around to doing it. The PPA intended to use people’s inertia to their advantage, by automating future increasing in retirement savings (with an opt-out, of course).
Third, the PPA provided for much better default options for plan sponsors that auto-enroll their employees in 401(k)s. Before the PPA, many of the relatively few companies that offered autoenrollment tended to invest participants’ contributions in money market funds or other extremely safe investments that are poor long-term holdings. Plan sponsors feared that if they invested the money more aggressively, they might expose themselves to participant lawsuits in the event of a market downturn that caused losses to participant accounts. The PPA gave plan sponsors protections if they selected an appropriate “qualified default investment alternative,” such as a target-date fund or a managed account.
The PPA 10 Years Later
By most relevant metrics, the PPA has been a tremendous success that “people should feel really, really good about,” says Ann Combs, head of government relations at Vanguard. Data from Vanguard and Fidelity, two of the nation’s largest 401(k) providers, confirm that the PPA has successfully increased the number of workers saving for retirement.