Despite many successes, 401(k) plans can fall short

It’s clear that 401(k) plans have been huge successes in the 40 years since they were authorized, amassing more than $5 trillion in assets and becoming investment mainstays for millions of Americans through workplace-benefit programs.

But 401(k) plans and similar definedcontribution programs haven’t worked out well for everyone, and criticisms linger. As the 401(k) concept marks the 40th birthday from its creation in the Revenue Act of 1978, here’s a look at some of the shortcomings:

Perhaps the biggest complaint about 401(k) plans is that they aren’t traditional pensions, where employers hire professional managers to run the show and ensure payouts for retired workers.

Still, 401(k) plans have supplanted traditional pensions, as companies find them cheaper to run, with less risk in terms of guaranteeing results.

With 401(k)-style programs, workers themselves are responsible for making decisions that will affect their investment success. For astute investors, that’s not bad. Many of these people value 401(k) plans for the control and flexibility they provide, allowing each person to decide how much to put away and which investments to select.

Also, 401(k) accounts are portable, meaning you can take your funds with you when switching jobs.

The 401(k) recipe has worked well for many. Fidelity Investments recently reported that 187,000 people with 401(k)s managed by the firm had portfolios of at least $1 million as of the third quarter, a 41-percent rise from a year earlier (though representing just 1 percent of all accounts). The average balance overall hit a record $106,500.

But not everyone is up to the investment challenge, and not all plans are attractive.

Millions of workers would be better off with pensions if their employers offered them. But that prospect isn’t likely, so 401(k) critics who pine for the return of traditional pensions, especially at the small firms that never offered them, aren’t being realistic.

Even assuming 401(k) plans are good programs — which isn’t the case in all

situations — a lot of workers don’t have the ability to participate or don’t take advantage of it.

In 40 years, the spread of 401(k) plans has been impressive, but it hasn’t filled all the gaps. Only 58 percent of workers had access to any retirement plans through work, and just 49 percent participated, according to a 2016 estimate by Pew Charitable Trusts.

Stated differently, only about 30 percent of workers use 401(k)s. Coverage and participation are lower at small companies and among part-time and lower-paid workers.

A big reason the wealth gap has increased in America reflects the concentrated ownership of the stock market and housing assets by affluent people. Both real estate and, especially, stocks have rebounded from the last recession, but millions of Americans haven’t participated in the recovery because they aren’t in the game.

There’s not much 401(k) plans can do about housing (which isn’t offered as an investment choice, at least directly), but the programs represent an important portal to the stock market for workers of modest means.

Mainly this comes through investing in mutual funds, the mainstays of most 401(k) programs.

Plenty of 401(k) plans, especially those at small companies, often lack key features that boost the odds for success.

The best plans offer a reasonable but not overly extensive choice of perhaps nine to 12 investments featuring moderate annual expenses below roughly 0.5 to 0.75 percent or so annually ($5 to $7.50 for every $1,000 invested).

Good plans also feature generous employer matching funds to encourage workers to save. Many programs allow participants to borrow a portion of their assets, as loans give workers some assurance that they can tap some of the money in a pinch.

The advent of target-date funds also has been helpful, as these selections provide a mix of investments suitable for people at specific ages, growing more conservative over time.

Two relatively new features in 401(k) programs are automatically enrolling workers and gradually increasing their financial contributions — unless they opt out.

Both automatic enrollment and contribution increases take advantage of the propensity of many people for inertia, noted Lori Lucas, CEO of the Employee Benefit Research Institute.

“The same people who are reluctant to increase savings today may allow their contributions to be automatically increased over time,” she wrote in a blog. “Research shows they generally do.”

Modest participation partly reflects low financial literacy and a lack of insight in how workers can make 401(k) plans work for them. Although education has improved, it remains spotty. Some employers provide consultations, webinars and other helpful information tools; others don’t.

It’s easy for workers to become discouraged by the retirement challenge.

“The (financial) industry likes to create fear by saying things like Social Security won’t be there or benefits will be reduced,” said George Fraser, a retirement-plan specialist who helps companies boost participation. Rather, “You want to inspire hope that people will have a better life in retirement” and that they can succeed with their plans, he said.

Fraser likes to tell reluctant workers that they can start by saving as little as one penny from each dollar of earnings, then increase it by a penny each year for a while after that.

Couched in those terms, the effort doesn’t seem as difficult, especially as many people don’t even bother to pick pennies off the ground, said Fraser, managing director at Retirement Benefits Group in Scottsdale.

Some participants don’t seem to have a good plan for using the money they have accumulated.

Once workers retire, many move their 401(k) balances to individual retirement accounts as rollovers, preserving the taxshelter benefits. Many then leave the money alone, aside from taking minimum required distributions after age 701⁄2.

“For the most part, retirees’ drawdown strategy is simply to take the required minimum distribution,” Lucas wrote. “Our research shows that, depending on the size of the nest egg, only between about 12 to 27 percent of assets are drawn down over the course of the typical retirement,” referring to those people with 401(k) accounts.

Granted, this doesn’t seem like much of a problem. “After all, it means you didn’t run out of money,” Lucas said in a follow-up note.

But it suggests that people who have invested diligently for decades “still cannot bring themselves to live off of their hardsaved nest egg because there is too much uncertainty,” she added, citing health issues, stock market unpredictability and more.

Low drawdown rates point to a need for more education on withdrawing 401(k)/IRA funds, especially as it meshes with managing Social Security benefits, dealing with health concerns and other issues.

“The draw-down dilemma is one that the system does not appear to have adequately addressed,” Lucas said.