After 40 years, some say 401(k) is due for a facelift

Of all the major milestones the 401(k) has crossed, its most recent stands out.

Forty years ago, Congress paved the way for the birth of the nation's first 401(k) retirement savings plan when legislators added paragraph (k) to Section 401 of the Internal Revenue Code.

Since that day on Nov. 6, 1978, the 401(k) has grown and flourished, settling comfortably into households across America. Yet while many say it has aged well, plenty more say that it's time for a few nips and tucks.

"It's helped tens of millions of workers save somewhere between $10 trillion to $15 trillion when you count the money that's been transferred out of 401(k)s into IRAs," acknowledged Ted Benna, a benefits consultant who has been called the father of the 401(k).

Big numbers, indeed. The plans took off almost immediately after The Johnson Cos., the benefits firm co-owned by Mr. Benna, launched its plan in 1981.

By 1984, there were 17,303 401(k) plans holding $92 billion in assets, according to the Investment Company Institute. Today, 55 million Americans are active participants in some 555,000 401(k) plans, which held $5.3 trillion in assets as of June 30. "They've evolved over 40 years from a supplemental savings plan to the primary employer-sponsored retirement vehicle," said Lori Lucas, Washington-based president and CEO of the Employee Benefits Research Institute.

Whether that's reason to celebrate is open to question. Some retirement experts view 401(k)s as hopelessly inadequate to meet the retirement needs of average Americans, while others view them as just beginning to hit their stride, citing improvements such as auto enrollment, auto escalation and better investment education provided by plan sponsors.

Fans of 401(k)s say that workers are much better off today than they were with traditional pension plans. Only about 10% of workers in a traditional defined benefit plan actually received a full benefit at retirement age from the plan due to job changes or leaving the workforce, said Olivia Mitchell, a professor of business economics and public policy and executive director of the Pension Research Council at the Wharton School of the University of Pennsylvania in Philadelphia.

Defined contribution plans, in contrast, are portable, meaning whatever money is in the account belongs to the participant regardless of job changes.

401(k) critics, in turn, point to the meager retirement savings employees have been able to set aside, saying that workers often can't afford to make contributions and don't have the knowledge or support they need to make sound financial decisions about how to invest their retirement funds.

"The amount of money that people will fall short of when they seek to retire under the current 401(k) system is over $4 trillion," Ms. Lucas said.

Fans and critics do agree on one thing, however: Not enough Americans have access to 401(k) plans. They bemoan the fact that only about half of workers are participating in private-sector retirement plans, according to many experts.

"401(k)s are not ubiquitous. They're not broad-based," said Jack Towarnicky, Columbus, Ohio-based executive director of the Plan Sponsor Council of America, explaining that not all employers offer the plans and those that do are not required to make them available to part-time workers and contract workers.

"This is clearly not a perfect system. There is more that could be done to get people into the system," Ms. Lucas noted.

Retirement experts also acknowledge that participants don't always make good decisions. Many don't enroll in employer 401(k) plans, even when company matching contributions are offered, and if they do, they often contribute at low rates. Many are also ill-equipped to make decisions about how to invest their savings, often pulling money out of stocks when the market drops and buying them back at much higher prices when it rises.

During the recent market downturn last month, for example, participants transferred their money out equities and into bonds, according to the Alight Solutions 401(k) index, a barometer of 401(k) trading activity. The data showed that on Nov. 20 — the day the Dow Jones industrial average dropped by more than 2.2% — trading activity was more than twice the average amount with the vast majority of funds being transferred to fixed-income instruments from equity funds.

"If you're giving the average Joe and Jane on the street the keys to the car and saying 'you're in charge of your investment vehicle,' know that people aren't experts on this and they're going to make these somewhat suboptimal decisions with selling at the wrong time and buying at the wrong time," said Rob Austin, the Charlotte, N.C.-based head of research at Alight.

Whether due to poor investment choices or lack of participation, the amounts many individuals have in 401(k) accounts are paltry. In 2016, the typical working household headed by someone between 55 to 64 had a median of $135,000 in 401(k) and IRA balances, according to the Center of Retirement Research at Boston College. Those headed by individuals 45 to 54 had $97,000, while those headed by people 35 to 44 had only $40,000.

Income significantly influenced how much households were able to save.

Households in the top 20%, for example, were substantially better off than most others as they posted a median 401(k) and IRA balance of $780,000. Those in the lowest 20%, in contrast, had only $26,700.

"I think the 401(k) works well for higher-income people who start saving early, but for half of the population it really is an inadequate mechanism," said Alicia Munnell, director for the Center for Retirement Research.

Still, she and most experts agree there's no going back to the days of traditional pensions.

"People wax nostalgically about the defined benefit plan, but I don't think the defined benefit plan was going to be sustainable as the nature of the workforce changed," Ms. Munnell said, referring to the increase in worker mobility.

Plus, many are quick to note, a lot of pension funds face severe funding issues.

"The funding shortfalls that are plaguing many corporate plans and many state and local plans are not seen in the defined contribution environment," Ms. Mitchell said.

Skeptics nevertheless remain unconvinced.

"The 401(k) was an experiment about whether people could save for their retirement in a consistent way without employers being required to give them any help. The experiment really has failed," said Teresa Ghilarducci, an economist and director of The Schwartz Center for Economic Policy Analysis at the New School for Social Research in New York.

In recent years, Ms. Ghilarducci and Hamilton E. "Tony" James, executive vice chairman of Blackstone Group LP, have pushed their plan to enhance retirement security. It calls for mandatory retirement savings accounts that would require employers and employees to each contribute 1.5% of pay into government guaranteed accounts that would be managed by approved asset managers and paid out as an annuity.

The retirement industry, too, has lobbied for changes to address the shortcomings of 401(k)s. In 2006, Congress passed the Pension Protection Act, legislation that made it easier for companies to auto enroll employees, escalate their contributions and default them into professionally managed target-date funds.

"All those three things have made it much easier for workers to save and invest at low cost for retirement than used to be the case," Ms. Mitchell said.

Still, much more needs to be done, according to many retirement experts.

Mr. Benna, the architect of the 401(k), would like to see legislation requiring employers to automatically enroll employees and bump up their contributions by 1% of pay annually until they reach 6%.

He would also like to see solutions to the issue of 401(k) leakage, the premature cashing out of 401(k) accounts when employees change jobs. Even small-balance cashouts matter, particularly when they occur early in a career, retirement experts say.

The retirement industry is also pushing for ways to improve access to 401(k) plans. One proposal by the Department of Labor would give small businesses a greater ability to band together to offer their employees 401(k)s through open multiple employer plans. States as well are taking steps to broaden access, with a handful launching private-sector retirement savings programs. Under such programs, employees can save via payroll deductions into an IRA.

For a growing number of experts, though, the biggest issue on the horizon for 401(k)s is one that has hardly been addressed: how to help people spend down their retirement assets in a prudent manner.

Many retirees have trouble figuring out how to spend their funds in a way that allows them to cover their expenses without running out of money before they die, according to Ms. Mitchell.

"They don't know how to auto-invest the money in later life," she said.

Ms. Mitchell proposes that employers include a default deferred annuity into the 401(k) at retirement. As she envisions it, employees would have 10% of their 401(k) balances automatically placed in a deferred annuity, which they would receive at 80 to 85. It would apply to 401(k) account balances of $65,000 or more.

In the end, 401(k)s may come full circle as they start looking more and more like traditional pensions, according to experts.

It's about putting the "pension back" into 401(k) plans, Ms. Mitchell said.