Retirement Crisis May Be Looming

EDITOR’S NOTE: Contributing columnist, Steve Nicklas, expresses his views and insight on various topics in Marketplace column.

__STEVE’S MARKETPLACE__

Many participants in 401(k) plans are not okay — in terms of preparing for a prosperous retirement.

And this is not okay to industry watchers and top officials. In a nutshell, a retirement crisis may be looming in the U.S.

Since 1978, with the advent of 401(k)s, retirement plans offering a defined benefit or pension have been replaced. The alternative for many companies, large and small, has been the ever-popular 401(k) plan.

In a 401(k), only the contributions are defined for employees. The final tally from what they save and how they invest is undefined, or undetermined. Even though some employers match some of the contributions, the final result is not impressive — or okay.

That’s because the typical 401(k) plan has less than $20,000 in it, according to a report from the Employee Benefit Research Institute. This will hardly finance a healthy retirement.

To make matters worse, nearly half of the 401(k) participants have balances of less than $10,000. And with longer life spans, some people will be retired for more years than they worked.

Now some of these numbers are skewed by age. Younger employees will obviously have less in their plans than older ones.

However, there is ample cause for alarm. According to Vanguard, a major provider of 401(k) plans, the median balance for employees nearing retirement is well below $100,000.

This amount will hardly cover healthcare costs for most retirees. Or living expenses above what Social Security payments will cover. So it is not surprising that retirement is the top concern for Americans, according to a Gallup poll.

Companies receive tax breaks for offering retirement plans for their employees. And employees can avoid taxes on contributions into most plans (until they withdraw them).

These are powerful forces. In addition, employer matches are essentially free money. Even though employer contributions may be frozen for a period of time, they nonetheless embellish the returns on an employee’s account.

Participants who regularly contribute to their retirement accounts, whether a 401(k) in the private sector or 401(a) or 403(b) in the public arena, also benefit from a compounding effect. When the price of an investment declines, more shares can be purchased at the lower prices.

In addition, 401(k) plans are portable. When an employee leaves one job for another, he or she can roll the balance into a new plan. Or direct rollovers into Individual Retirement Accounts (IRAs) are also possible.

And for those dissatisfied with the investment options or the fees of their 401(k) plan, an in-service withdrawal would be transferred into an IRA. This can occur while someone still works for the employer and still participates in the 401(k) plan.

Some features of a 401(k) plan can also be a detriment. Often times, plans offer a numbing option of investments — while employees receive little advice on how to proceed.

In addition, studies have demonstrated that a typical investor will liquidate investments when the stock market declines, and jump back in after a rebound. In other words, they buy when prices are high, and sell when they are low.

With older retirement plans, employees would earn a pension after so many years of service. However, there is no guarantee within the 401(k) framework. And after two brutal downturns in the U.S. stock market in recent years, participants may be hesitant to invest.

Regardless, the proliferation of 401(k)s is dwarfing the number of traditional pension plans (or defined benefit plans). There are now 630,000 401(k) plans in the U.S., with 90 million participants and $4.5 trillion in assets.

“I’m not saying defined benefit plans are flawless, but they certainly didn’t put as much of the risk and responsibility on the individual,” says Terrance Odean, a professor of finance at the University of California/Berkeley.

Odean studied the investment process within 401(k) plans. When investors had to choose their asset breakdown, they typically underperformed. This was magnified when stocks were involved in the allocation.

Daniel Halperin, a professor at Harvard Law School, was a senior official at the Treasury Department when 401(k)s were developed. “Nobody thought they were going to take over the world,” Halperin says.

“The 401(k) plan changed two things,” Halperin says. “You could choose not to participate. And you chose your own investments, which a lot of people, I think, screw up.”

The pressure is mounting on aging workers with 401(k) plans. According to a Harris poll, more than 70 percent of Americans are worried about having enough income in retirement. And 86 percent of respondents in another survey say the country is facing a retirement crisis.

Meanwhile, some say the 401(k) experiment is a failure. You might truly believe this, when you look at the median balance of all the 401(k) plans out there: a paltry $18,433. That represents a crisis of some magnitude.