The 401(k) Has Failed. Let's Admit It

Why don't we just admit that the 401(k) is a failure and get on to designing something better?

I say this as the writer of an admiring book about every employee's favorite saving plan (Take Charge of Your Future, Warner Books, 2003), and I still think that 401(k)s are fine as a supplement to other plans. But while that's what they were conceived to be, that's not what they are anymore. They have become, by default, the only national retirement savings plan. That raises the bar considerably, and 401(k)s just can't clear it.

Here's what I'm not saying. I'm not saying that the main problem is that 401(k)s require ignorant workers to manage their investments wisely. (i have more faith in the average Joe's ability look out for himself than that.) I am saying that, even if every 401(k) participant were Warren Buffett, the plan still falls short of what you ought to expect from the nation's main retirement savings vehicle.

I'm also not saying that you should stop funding your 401(k). You still have to save for retirement and the 401(k), flawed as it is, is the best way we've got to do that. I am saying is that we should do better. We are asking the 401(k) to play a role for which it was never intended, and we should reshape the plan to fit that role, or get a new plan. Here's what's wrong with the 401(k):

It randomly creates winners and losers. Citizens who take part in a national retirement savings plan ought to know what it takes to succeed. It doesn't matter what the rules are, as long as they're fair and consistent. If you save more in the plan, you retire with more income. That would be a fine rule. If you earned more in your career, you get more retirement income. That works too. (It had better; it's the Social Security promise.)

But a 401(k) is way too much at the mercy of market cycles. You could earn the same money, save the same amount, invest as wisely as a colleague and still wind up eating the Denny's special while your doppelganger vacations in Greece. It all depends on where in your lifetime the inevitable market downturn falls. If early in your career, you'll build your nest egg by buying cheap assets and retire rich. If late, you'll find your life savings decimated when it's too late to rebuild. That's not fair. The nation's main retirement funding plan should not be a conduit for administering random acts of fortune. It should aim to alleviate randomness.

The plan provides inadequate income Left to their own devices, most employees don't put in enough money to make a dent in their retirement needs. And even if they start out putting enough money in, when times get tough, they suspend contributions to meet short-term cash needs. Even worse, employers have begun to do the same. According to surveys, about a quarter of employers have stopped, or plan to stop, matching their employees' 401(k) contributions. This happening at the worst possible time, of course: when stock prices are 40% cheaper than they were 18 months ago.

The plan exposes everyone to the risk that they'll live too long Because you don't know when you'll die, you have to save as if you'll live to be Methuselah, just to be safe. The usual financial planner's target is age 95. If you saved the fortune you need to cover yourself to that age and don't make it that far--and most people won't--tough luck. If you do live that long and you didn't save enough--and again, most don't--even tougher luck. The shame of this is, longevity risk can be insured away by averaging out the risk over an entire population. Every annuity does this. Why not the national retirement savings plan?

Congress today is going to take up something they're calling the 401(k) Fair Disclosure and Pension Security Act. It will nibble at the edges of the 401(k) problem, acting as if lowering fees on 401(k)s would solve the problem. It won't. The plan needs a real overhaul.