401 (K) Plans Move Away from Employer Stock as Investment Vehicle: Increasingly, Employees Are Given the Option to Choose How Their 401(k) Plan Funds Are Invested; This Greater Choice Is One Factor in the Decreased Exposure to Investment in Employer Stock

By Wiatrowski, William J. | Monthly Labor Review, November 2008 | Go to article overview

401 (K) Plans Move Away from Employer Stock as Investment Vehicle: Increasingly, Employees Are Given the Option to Choose How Their 401(k) Plan Funds Are Invested; This Greater Choice Is One Factor in the Decreased Exposure to Investment in Employer Stock


Wiatrowski, William J., Monthly Labor Review


The Pension Protection Act of 2006 seeks to encourage expanded participation in 401(k) plans by al lowing new employees to be automatically enrolled in such plans, and, in the absence of an employee decision, clarifying the rules for investment of plan assets. Regulations to implement this law, finalized by the US. Department of Labor in October 2007, specify that a "participant in a participant directed individual account pension plan will be deemed to have exercised control over assets in his or her account if, in the absence of investment directions from the participant, the plan invests in a qualified default investment alternative," which establishes a general prohibition against holding or permitting acquisition of employer securities. (1) This effort to ensure that employee accounts are invested in a diversified portfolio is a change from the earlier history of 401(k) plans, when investment in employer stock was prevalent. As plans begin to adapt to these new regulations, a look at the trend in 401(k) investment options over the past two decades shows a steady move away from employer stock as an investment vehicle. Should plans choose to expand the use of automatic enrollment features as a means of further encouraging participation, the regulations requiring the use of qualified investments might result in further movement away from investment in employer stock.

401 (k) plans, in brief

Internal Revenue Code section 401(k) was introduced as part of the Revenue Act of 1978. (2) Commonly known as "401(k) plans," these kinds of plans first came into prominence in the early 1980s. Section 401 (k) defines a feature of a defined contribution plan that allows employees to choose to defer some income (and, consequently, defer current taxation of that income) into a retirement account. In general, defined contribution plans are individual accounts that accumulate employer and employee contributions, plus earnings, the result of which is available to the employee at retirement. The most prevalent 401 (k) plan is known as a savings and thrift plan (or some variant such as a thrift-savings plan), which gives the employee the option to invest some percent of earnings that is then matched by employer funds. For example, a plan might allow the employee to contribute from 1-10 percent of their earnings, tax deferred, with the employer matching 50 percent of the first 6 percent of earnings contributed. If the employee chose to contribute 10 percent, the employer would add 3 percent (50 percent of the first 6 percent). The total of 13 percent of earnings would then be invested in the employee's account. (3)

There are other types of defined contribution plans and other ways that section 401(k) is used to allow pretax contributions. In all cases, the total employee and employer contributions are invested, with the employee bearing the risk of investment gains and losses. The investment choices for 401 (k) plans have changed considerably over the past 20 years, reflecting changes in law and regulation, the expanded use of 401(k) plans as the primary vehicle for providing retirement income, and heightened concern that employees should be properly educated about investment choices. (4)

401(k) investment options

The Bureau of Labor Statistics (BLS) tracks the percent of workers who participate in various types of employee benefits, as well as the details of those benefits. Following the introduction of 401(k) plans, BLS expanded its benefits survey in the mid-1980s to incorporate defined contribution plans. Since then, BLS data have tracked the increased participation in defined contribution plans and the decreased participation in defined benefit plans. By capturing the provisions of 401(k) plans, BLS has also tracked the movement toward allowing employees to choose their own investments and the decline in the use of employer stock as an investment vehicle. (5)

The typical plan consists of employee contributions and employer matching contributions, each of which can be invested in a variety of vehicles. …

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