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401(k) Plans: Not Dead Yet

These plans may need some improvement, but they're not ready for the scrapheap.

The worst market meltdown in 80 years exposed the flaws of 401(k)s and similar defined-contribution plans, which shift the burden and risk of saving for retirement from employers to employees. Lawmakers have called for greater scrutiny of 401(k) investments and fees. Time magazine declared 401(k)s a financial flop and recommended that they be retired.

We disagree. The plans, which have become the default retirement-savings vehicle for nearly 50 million Americans, have enabled individuals to amass more than $14 trillion over the past 25 years. They may need improvement, but they're not ready for the scrapheap.

Automatically enrolling workers in 401(k) plans is a good first step. About half of all employees now have access to a retirement-savings plan at work -- about the same percentage as in the "good old days," when traditional pensions were the primary retirement benefit.

But keep in mind that the so-called golden age of traditional pensions is largely a myth. Even at the peak of pension coverage in the 1980s, only about a third of private-sector workers were covered by traditional defined-benefit pension plans. Today it's less than half that much. Faced with competition in an increasingly global marketplace, U.S. firms have been abandoning expensive pension plans in droves over the past 20 years. (Most government workers still have access to traditional pensions. But, like their counterparts in the private sector, some jurisdictions have been scaling back coverage for new hires, and others are wondering how they will pay for the obligations already on the books.)


As a result, 401(k) plans, or their equivalent, are here to stay. Rather than retiring 401(k) plans, we should put them to work more effectively. For employees, that means saving more, investing more appropriately and figuring out how to turn a lifetime of savings into an income stream they won't outlive.

Some solutions are already in the works. In addition to automatic enrollment, many employers now offer escalation features that let workers elect to bump up their 401(k) contributions automatically in future years. And more than 78% of employers offer target-date funds to help workers invest more appropriately. Some of these funds have been criticized for investing too aggressively as they approach their target date, when workers near retirement. Nevertheless, they are a vast improvement over leaving workers to their own devices (read Target-Date Funds Reset Their Sights).

Other enhancements, such as making investment advice more broadly available in the workplace, will take longer. The Department of Labor recently scrapped a controversial rule regarding who could advise 401(k) participants, citing concerns about potential conflicts of interest. Now, the DOL has to go back to the drawing board. "I don't think the current retirement system is broken, but I think we're in the midst of a crisis of confidence," says Phyllis Borzi, assistant secretary of labor in charge of pensions and employee benefits. "You can put a lot of bells and whistles on 401(k) plans, but they will never offer the same level of retirement security [as traditional pensions] if individuals bear all the investment risk."

A lot of ideas are kicking around, including creating a mandatory retirement system for all workers. (We already have one. It's called Social Security.) Some people want to make it easier for the 50% of employees who don't have access to a retirement plan at work to save for retirement. (Ditto. It's called an IRA.) Creating what Borzi calls Plan C could take a while. In the meantime, keep feeding your 401(k).