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Is this really the last 401(k) generation?

Posted on Mar 20, 2012 by  in 401(k) Retirement Planning, In the News, Retirement Plans for Business

Recently I came across an article by Linda Stern entitled “The last 401(k) generation” which I found to be a bit alarming.  Yet another commentator seems to be trying to paint 401(k) plans as a failure.  Specifically, Ms. Stern states that they have been “sort of a failure.”  Even so, I feel that characterizing 401(k) plans as a “failure” or even as “sort of a failure” is misleading and inaccurate.  The truth is really quite the opposite. 

The article states that there are two significant shortcomings of the 401(k) plan.  The first is the 401(k) is not powerful enough to secure the retirements of low-income workers who can’t afford to stash enough away.  The second is the 401(k) environment leaves each accountholder alone to manage risks.

While it is true that most lower income workers don’t have a lot of extra money to put away into their 401(k) plan, there is nothing wrong with starting small.  To attain a reasonable income replacement rate in retirement, lower income workers don’t need to start off making large contributions as long as they start early and are consistent in making their contributions.  An article in MSN Money in January points out that even someone who earns $35,000 can save a million dollars in their 401(k) plan if they save at 12 to 13 percent.  Also, a worker that makes $35,000 a year will have to save a lot less than a worker making $200,000 a year to achieve the same income replacement rate.  In some ways, attaining a reasonable income replacement rate for higher wage earners can even be more challenging due to contribution and deferral limits imposed on 401(k) plans.

Other factors that play a role in the inadequacy of retirement savings are in-service distributions, hardship distributions, and participant loans.  Workers who use their 401(k) plan as a personal bank from which they withdraw or borrow seriously restrict the growth of their account.  While workers are often permitted to take loans for any reason, the average employee doesn’t really understand that taking a loan to buy a new motorcycle or car has a large impact on his or her retirement savings.  To make matters worse, workers who take plan loans often also reduce or stop making 401(k) contributions because their budget can’t support both loan payments and 401(k) contributions.  The interest that they are paying on the loan is usually more than offset by their reduction in contributions.  This is especially true where there is an employer match that they are missing out on as well. 

With respect to Ms. Stern’s second point, most plans that allow workers to direct their own investments don’t leave participants to manage the risks alone.  Even employers wishing to comply with section 404(c) of the Internal Revenue Code have the responsibility to prudently select and monitor the plan’s investment options and provide participants sufficient disclosures about the plan’s investment options on an ongoing basis.  Under the law, all participants must be supplied with resources that they can use when selecting their investments. 

Perhaps the most compelling defense of 401(k) plans comes from a survey conducted by Fidelity Investments in the fall of 2011.  According to that survey 55% of current workplace savings plan participants say they would NOT be saving for retirement at all if it were not for their 401(k) plans.  The real “failure” in would be to abandon the 401(k) plan which enables millions of American workers to prepare for a successful retirement.

The 401(k) saver who makes small sacrifices today will avoid having to make larger sacrifices in retirement.

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