A Bold 401(k) Overhaul

There's no longer any debate over whether working Americans are accumulating enough savings and employer contributions, supplemented by Social Security, to live comfortably in retirement. Indisputably, they are not, and the matter is getting critical.

As a result, the debate has shifted to whether today's 401(k) and 403(b) plans should be reformed, or be replaced or supplemented with something entirely new, such as the proposed government-sponsored Guaranteed Retirement Accounts conceived by economist Teresa Ghilarducci, the USA Retirement Fund idea of Sen. Tom Harkin (D-Iowa) or something else.

Each of these new plans has its merits. But, for a variety of reasons, I don't see any realistic prospect of a brand-new system, especially one with heavy federal involvement during an era of tight revenue.

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Washington will have its hands full devising big changes in Medicare and small changes in Social Security to keep them financially viable and help rein in the overall budget deficit. Given today's legislative paralysis, that's about all we can expect of Capitol Hill and the White House. In any event, the financial-services industry, fearing it would be cut out of a replacement plan for 401(k)s, would use its political clout to block it.

Sweeping changes. Fortunately, scrapping the present system isn't necessary. Reform would be enough—as long as it's a bold overhaul, not just tinkering around the edges. Two years ago, I laid out a blueprint for such a plan in this column (see 401(k)s for Everyone):

Coverage. Every employer in America, regardless of size, would be required to offer a 401(k) or 403(b) account to all employees, full- or part-time.

Funding. Both the employer and employee would be required to make a tax-free contribution to the account—ideally, at least 3% each for younger employees (6% total), rising with age to a combined 12%.

Investments. Asset choices—now too numerous and confusing to many employees—would be narrowed to include mostly low-cost index funds (stocks and bonds) and exchange-traded funds. Employees would receive advice on an appropriate asset allocation for their situation, or they could choose a default mix, such as the one long recommended by Vanguard founder John Bogle: The percentage of bonds in an account would equal the employee's age, with the rest in domestic and foreign blue-chip stock index funds.

Management. Members of the financial-services industry would continue to manage these accounts, but there would be caps on management fees.

Withdrawals. To deal with a troub­­ling situation that arose during the Great Recession—that is, employees raiding their 401(k) accounts for living expenses—no loans or early withdrawals would be permitted before age 65, except in the case of permanent disability. (Yes, my plan would ban the kind of home down payment discussed in Game Plan.) In retirement, a 401(k) balance would be paid out gradually according to life-expectancy tables, like an annuity. Unlike an annuity, however, whatever was left at death would become part of the retiree's estate.

When I first proposed this sweeping overhaul, I predicted that "some libertarians will argue that mandatory retirement saving, like mandatory health insurance, would be an imposition on their personal freedom." And that's exactly what I heard from some of our readers.

They're right. But I believe this imposition would pale in comparison to the huge financial burden that nonsavers and short-sighted employers—in a purely voluntary retirement system—will surely impose many years from now on a compassionate society.