Here are some interesting facts. 401k Plans have been for the most part a failure for their entire thirty five year existence. Those who designed the plans and backed their introduction now say they haven’t worked. They add that they regret how they have turned out.
Additionally, in this country we are at the beginning of what will be a retirement crisis of major significance. The failures of the 401k program are a major cause. But notwithstanding the failures and regrets, 401k Plans continue to be the means by which most Americans do save for retirement.
The list of what has gone wrong is long and extensive, and there is plenty of blame to go around.
In their earliest design some say it was intended that 401k Plans would only supplement the pensions that private sector employers funded for their employees. Instead, employers by and large ended their pension plans when 401k plans were introduced. They did this, of course, for cost reduction purposes. In fact, today only 13% of private sector employees have pensions as compared to 38% in 1979. So justified in large part by the passing of 401k legislation, today almost 90% of private sector employers hand over full responsibility for retirement funding to their employees.
Another problem was that the designers oversold the program and that their math and projections were wrong. The designers stated that employees would only need to set aside 3% of their income in order to have enough to retire. And they assumed investments would grow by 7% per year. Those numbers were all way beyond reality.
In the beginning the Employer Match was a key part of most 401k Plans. The primary funders of 401k plans were always intended to be the Employee. But from the Employees’ viewpoint the best part of a 401k plan was the Employer Match. This was “free money” added to their retirement account. The problem is that over time as the business climate became more and more difficult, companies declined to provide a match or significantly reduced the amount of their match.
Another problem is that more than thirty million workers do not have access to any employer sponsored retirement plan because many small businesses do not provide a 401k Plan.
Two other issues have turned out to be major weaknesses with 401k plans as well.
The first is that money managers have been allowed to make excessive fees from 401k investments. These fees should have been limited. And secondly, employees make too many costly mistakes in managing their accounts. It is too much responsibility for most and thus costly mistakes occur. Common mistakes are taking money out during market downturns, making bad investment decisions, and accessing the money for non-emergency needs.
But the single biggest problem with 401k plans is that too few employees year after year have chosen to participate in their Employers’ Plans. Many employees never seemed to understand what’s at stake for their futures. Employees were never able to wrap their head around the idea of a “salary reduction plan”, another name for a 401k plan. They need to understand that they will be exposed to big fluctuations in the stock market and that it is a long term game. A better job needs to be done to sell all of this to employees and unfortunately that has never happened. As a result, while participation levels in 401k plans have improved in recent years, the level of non-participation still hovers around 33%. Another third under-fund their accounts.
In spite of all of these problems…
401k plans have been a vehicle that has served those who are committed to saving. People in their 60’s who embraced the plans and have been saving diligently since the early to mid- ’80’s have average savings of $304,000 according to the Employee Benefit Research Institute.
I believe, however, that changes can and should be made to eliminate the weaknesses in 401k Plans so that almost everyone could begin retirement with a healthy balance in a 401k account(s). I suggest considering the following:
- Require all private sector employers to offer a 401k program.
- Require all companies with at least 25 employees to offer at least a minimum match.
- Require all employees to participate with a minimum salary contribution of perhaps 3 or 5%.
- All commissions and fees paid to money managers for 401k Plans should be limited. And they should be clearly transparent to the employee.
- Employers should provided 4 hours of education per year on “Managing Your 401k Plan”.
- Finally make it more difficult to access an these accounts before retirement.
While these changes would come too late for most Baby Boomers, certainly future generations would benefit.