Eleven Biggest Flaws With 401(k) Plans
- Not enough people even have a 401(k) plan--53% of the population isn’t covered. Since fewer than 10% of the population has a regular pension, a huge chunk of Americans depend solely on Social Security, whose typical benefit is around $12,000 to $20,000 a year.
- Even those people with 401(k) plans can’t retire because employers don’t contribute enough. The meager 3% contribution rate is the lowest in the advanced world. Australia’s contribution rate is equal to 9% of pay, Denmark’s is 11.8%, Hungary’s is 8 %, Mexico’s is 6.5%, Poland’s is 7.3% and the Slovak Republic’s is 9%.
- Vesting doesn’t start right away so employees don’t “own” all employer contributions. In 2011, only 45% of plans surveyed by the Vanguard Group immediately vested participants in employer-matching contributions--that is allowed them to “own” employer contributions--rather than making them wait a year or more. This hurts the majority of Americas, who are job changers. According to the Bureau of Labor Statistics, the average American born in the latter years of the baby boom worked for more than 10 employers between the ages of 23 and 44 alone.
- Despite the Enron debacle employers can still get away with matching in company stock, which can potentially be worthless. Incredibly, 12 years after the Enron scandal, it’s still legal for employers to contribute stock instead of cash. As a result, nearly one in five of the nation’s more than 52 million 401(k) participants have more than 20% of their balances in it.
- Employees aren’t told how much to contribute and the folks who advise the plans appear to be clueless. The Vanguard Group’s 2012 “How America Saves” report says employees should save 9 to 12% of their salaries and software offered by Financial Engines to Vanguard participants doesn’t communicate a savings goal or the contribution rate needed to achieve that goal. In reality your savings rate depends on how long you waited to start contributing. If you start at age 25 you need to save 10% of your salary, increasing to 17% at age 35, 23% if you wait until you’re 40 and a whopping 48% of pay if you wait until age 50. Needless to say, this over-50 requirement flies in the face of the meager $5,500 limits on catch-up contributions allowed by the IRS for those over 50. What’s more, we’ve never seen mutual fund managers communicate a savings goal based on actuarial methodology--which is achieving AT LEAST 10 times your “final pay,” or salary right before you retirement, in your current and rollover accounts.
- As a result, employees don’t contribute enough. According to “How America Saves” the median employee savings rate was 6% and only 22% contributed more than 10% of pay. What’s more, employers can simply “auto-enroll” employees who don’t join on their own at a measly employee contribution rate of 3% and gradually “auto-escalate” them to an inadequate 6% rate.
- Employees don’t put all of their assets into one-stop-saving target date funds, which reduces the stock allocation as they get closer to retirement, missing the whole point of these funds. Less than one-quarter of Vanguard participants are wholly invested in a single target-date fund.
- Employers often pick the wrong funds, then replace them with funds they are likely to replace rather than picking a “fund for life.” According to Deloitte’s 2011 401(k) Benchmarking Survey, 66% of employers replaced an underperforming fund within the previous two years and 43% did so within the previous year.
- Only a tiny percentage of employees use online tools that help them look at ALL account balances to see if they are on track nor are they told what their savings goals should be. While Vanguard offers software from Financial Engines its spokesperson says that it doesn’t communicate a savings goal to participants. What’s more, only 5% of Vanguard’s participants use the software and only about 6% of Fidelity Investments’ 11 million participants use theirs. Only one in five of Deloitte’s plan sponsors have conducted a “retirement readiness assessment”--most likely because employees would be furious to find out that they can’t afford to retire. As a result, the majority of Americans have no clue that they are not on track.
- People can borrow and cash out when changing jobs. Typically nearly half of job changers cash out of at least part of their account balances rather than leaving money in the plan or “rolling it over” to an IRA or new plan. While it’s understandable that a job loss can cause financial stress, folks would be better off seeking help from family members since a “cash-out” can result in losing a big chunk of the money as a result of tax obligations; someone in the 25% tax bracket cashing out a $20,000 account balance could be left with only $12,000.
- “Catch-up is not a vegetable.” We need to remove the puny annual $5,500 ceiling on “catch-up” contributions for those over 50. Baby Boomer Australians can contribute up to $450,000 to their version of 401(k) accounts as a result of a sale of a home, which, along with the more generous mandatory employer contribution rate, is the major reason why Australians in their 30s expect to have account balances of $500,000 to $700,000-more than 10 times that of their American counterparts.
DISCLOSURE: THIS INFORMATION IS INTENDED FOR INFORMATIONAL PURPOSES AND DOES NOT CONSTITUTE ANY TAX, FINANCIAL PLANNING, INVESTMENT OR LEGAL ADVICE. CONSULT YOUR FINANCIAL, TAX OR LEGAL ADVISER REGARDING YOUR OWN UNIQUE SITUATION AND YOUR COMPANY'S BENEFITS REPRESENTATIVE FOR RULES SPECIFIC TO YOUR PLAN.
Interviews with Jane White:
09/30/2009: Book Review: Welcome to the Poorhouse by Miranda Marquit
"Jane White: Your 401k Isn't Enough" by Miranda Marquit
10/08/2009: "Recession is Best Time to Revive Your Retirement Plan" by Kimberly Amadeo, About.com
America, Welcome to the Poorhouse Book Review by Kimberly Amadeo, About.com
10/08/2009: "10 Steps to Avoid the Retirement Poorhouse" by Gary Stern, Minyanville.com
10/22/2009: "Tip: To retire at 65, you need 10 times your salary." by Peter King, NewsDay.com
10/23/2009: "Bookshelf: Retirement Plans Under the Microscope.", NYTimes.com
12/09/2009: "Join the revolt by sending out some e-mails.", by Barbara Whelehan at Bankrate.com
12/10/2009: "America, Welcome to the Poorhouse." by Heather at TheGreenestDollar.com
12/10/2009: "Book Review & Giveaway: "America, Welcome To The Poorhouse" by FinancialSamurai.com
12/11/2009: "REVIEW: America, Welcome to the Poorhouse (Jane White)"by Wojciech Kulicki at Fiscalfizzle.com
12/16/2009: "Review of Jane White's America, Welcome to the Poorhouse" by Michael Dink, www.dinksfinance.com
12/17/2009: "Interview with Author Jane White" by Michael Dink, www.dinksfinance.com
12/19/2009: "America, Welcome to the Poorhouse", www.northerncheapskate.com