Do 401k plans still make sense?

Defenders of 401(k)s say the plans shouldn't be judged prematurely. The 401(k) "is doing what it's supposed to do, which is generate retirement savings," says David Wray, the president of the Profit Sharing/401(k) Council of America, an association of employers who offer such plans. "When the entire American work force has 30 or 35 years in the 401(k) plan, then you'll see very substantial balances."

While 401(k) participants have been through stock slides before, now they are also grappling with declines in home values and tighter consumer credit. What's more, health care costs are rising fast, and people are living longer.

These converging pressures are prompting many 401(k) savers to postpone retirement and adjust to a lower standard of living.

• Calculator: How much do you need to save for retirement?

Some are rolling the dice in an attempt to make up for losses.

Jeff Goodman, a 38-year-old computer programmer in Indian Trail, N.C., watched his 401(k) slide more than 40% last year. He's not happy with the plan's investment options, which have almost all been hammered in the downturn.

He's contributing only enough to get the company's matching contribution. About two months ago, he opened a brokerage account and started trading stocks and options. He lost roughly $3,000 on a complex options trade. Still, he's not convinced the 401(k) is the best savings vehicle. "In a recessionary time, you just can't do the buy-and-hold thing anymore," he says.

Part of the problem, critics say, is that the 401(k) is trying to fill a role it was never designed to play. The plans were born with little fanfare in 1978 when Congress added section 401(k) to the Internal Revenue Code. Initially, many employers saw them as a supplement to company-funded defined-benefit plans and Social Security -- and a way for executives to stash some of their compensation in tax-deferred accounts.

But the legislation marked the beginning of the end of professionally managed pensions that provided guaranteed benefits to retirees.

As big employers recognized that 401(k)s are substantially cheaper than defined-benefit plans, the employee-managed accounts moved from supporting role to center stage. Many workers didn't even participate in the voluntary plans, which meant that employers didn't have to make matching contributions. What's more, employers aren't required to contribute to the plans at all.

The plans appeared near the beginning of a long bull market. For years, strong stock market returns smoothed the transition from guaranteed pensions to worker-driven plans, masking careless investment choices by individuals and high fees charged by some companies that administer plans.

But according to Boston College's retirement research center, Americans were becoming less prepared for retirement. Four of 10 working-age households were at risk of being financially unprepared for retirement in 1998, according to the center, up from less than one-third in 1983. By 2006, the figure stood at 44%.

Some big employers cut back

Not saving enough has always been a big problem for 401(k) participants. The tough economic times are exacerbating that tendency. In 2007, the median account balance for 55- to 64-year-olds in defined-contribution plans such as 401(k)s administered by Vanguard was just $60,740, and only 10% of all participants saved the maximum dollar amount in the plans.

Over the past year, about one in five workers age 45 or older has stopped contributing to a 401(k), IRA or other retirement account, according to a recent survey commissioned by the AARP, an advocacy group for older people.

Peg Kelley, a 58-year-old small-business consultant in Watertown, Mass., didn't contribute anything to her 401(k) last year. Instead, she's focused on paying down credit-card debt and building an emergency fund in case the bad economic times turn worse. She's also still paying off an $8,000 loan she took from her 401(k) plan four years ago to buy a new car.

Afraid of reliving the dot-com market meltdown, which knocked $100,000 off her retirement savings, she moved her entire 401(k) from diversified stock and bond holdings into cashlike investments early last year.

"I'm not going to get rich on my 401(k)," she says, "but also don't want to get poor because of it." She had hoped to retire early, but now she figures she won't quit work before age 65.

Matching contributions from employers are a major incentive for workers to contribute to their plans. The typical matching contribution amounts to 3% of pay. But some employers are cutting back. General Motors and FedEx, for example, are suspending 401(k) matching contributions.

One proposal floated at the congressional hearings was to require companies to make contributions.

Continued: A scarcity of low-cost options

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