Do 401k plans still make sense?

By The Wall Street Journal

After watching her account drop 44% last year, Kristine Gardner, a 35-year-old information-technology project manager in Longview, Wash., feels no sense of security.

"There's just no guarantee that when you're ready to retire you're going to have the money," she says. "You either put it in a money market which pays 1%, which isn't enough to retire, or you expose yourself to huge market risk and you can lose half your retirement in one year."

Many retirement experts have come to a similar conclusion: The 401(k) system, which has turned countless amateurs like Gardner into their own pension-fund managers, has serious shortcomings.

"This is the biggest test that the 401(k) plan has seen to date, and it has failed," says Robyn Credico, the head of defined-contribution consulting at Watson Wyatt Worldwide, noting that many baby boomers are ready to retire. "We've put people close to retirement in a very challenging position."

The most obvious pitfall is that 401(k) plans shift all retirement-planning risks -- not saving enough, making poor investment choices, outliving savings -- to untrained individuals, who often don't have the time, inclination or know-how to manage them.

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But even when workers make good choices, a market meltdown near the end of their working careers can still blow their savings to smithereens.

"That seems like such a fundamental flaw," says Alicia Munnell, the director of Boston College's Center for Retirement Research. "It's so crazy to have a system where people can lose half their assets right before they retire."

Congress has begun looking at ways to overhaul the 401(k) system. At hearings in October, the House Education and Labor Committee heard from a variety of witnesses. Some proposed setting up "universal" retirement accounts, which would cover all workers.

One such plan called for establishing accounts that would receive annual contributions from the federal government and would offer a guaranteed, but relatively low, rate of return.

Another proposed automatically investing contributions in an index fund that holds stocks and bonds, with the mix getting more conservative as workers approach retirement.

Other witnesses proposed less drastic changes, such as providing better education.

About 50 million Americans have 401(k) plans, which have $2.5 trillion in total assets, estimates the Employee Benefit Research Institute in Washington. In the 12 months after the stock market's peak in October 2007, more than $1 trillion worth of stock value held in 401(k)s and other "defined-contribution" plans was wiped out, according to the Boston College research center.

If individual retirement accounts, which consist largely of money rolled over from 401(k)s, are taken into account, about $2 trillion of stock value evaporated.

Broad shift to 'ownership society'

The losses are hitting as baby boomers, the first generation to rely heavily on such plans, are beginning to retire. Workers age 55 to 64 who have been in their current plans for 20 years or more saw their 401(k) account balances, on average, drop roughly 20% last year, according to the Employee Benefit Research Institute. Since those figures include new cash contributions to the plans, they understate investment losses.

Participants in 401(k) plans contribute chunks of their pretax pay to an account, which may be invested in stocks, bonds, money-market instruments and other holdings. Each employee typically decides on his or her own mix. At many companies, if an employee contributes to the plan, the company also kicks in some money.

For many workers, 401(k)s have come to replace "defined-benefit" pension plans, which pay a specified amount to employees who retire after a set number of years.

As such, the plans represent a key component of the broad shift in recent years toward an "ownership society," in which individual Americans are expected to play a bigger role in managing large financial risks such as saving for retirement and paying for health care.

In most plans, "it's been the Wild West of 401(k) investing," says Jerry Bramlett, the president and chief executive of 401(k) record-keeping firm BenefitStreet. "You show up at work, they give you a list of funds and send you on your way."

Continued: Cheaper than defined-benefit plans

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