The ABCs of 401(k) Plans

Changes to these popular retirement vehicles are on the horizon.

May 28, 2015

“An overwhelming majority of Americans believe there is a retirement crisis,” says the National Institute on Retirement Security, which reports that three of four consumers “remain highly anxious about the retirement outlook.” 

American consumers do feel slightly more optimistic about retirement prospects than during the economic crisis. Although 74% are “highly anxious” this figure has dipped from 85% in 2013.

Nonetheless, 67% of workers would accept less pay for guaranteed retirement income.

Further, consumers largely think retirement benefits are almost as important as salary” (72%), according to the survey.

Retirement planning vehicles compose an “alphabet soup” of options: DB plans, IRAs, 401(k) and 403(b) plans, to name a few.

Consider that “401(k) plans have grown to be the most widespread private-sector employer-sponsored retirement plan in the U.S.,” says the Employee Benefits Research Institute.  Fifty-three million Americans participated in such plans in 2013, and by the end of that year, assets in 401(k)s “represented 18% of all retirement assets, amounting to $4.2 trillion.”

This week, learn the ABCs of the 401(k): Its origin, associated risks, employee and employer behaviors concerning the plans, and anticipated changes.

These trends are impactful for both workers and employers given the significance of 401(k) plans as a component of retirement planning.

‘A good plan today is better than a perfect plan tomorrow.’—George Patton

The Great 401(k) Experiment Has Failed for Many Americans,” says NBC News. The median amount in a 401(k) account is $18,433, but nearly 40% hold less than $10,000 “even as the proportion of companies offering alternatives like defined benefit pensions continues to drop.”

More than three-fourths of employers offer 401(k) plans as the primary retirement plan choice, most offering a contribution match.

However, the responsibility shift from employer to employee of growing retirement income has been a problem due to stalled wages and workers’ lack of investment knowledge.

The plans “were never designed as the nation’s primary retirement system,” notes research economist Anthony Webb. “They came to be that as a historical accident.”

As they grew in popularity, defined benefit plans began to disappear when workers “overvalued the promise” and employers found lesser costs.

The problem: As consumers make their own investment choices, there is a great possibility of shortfalls in funds. Further, participation in 401(k)s is optional.

Disbursement choices also create challenges. Consequently, 52% of households “were at risk of being unable to maintain their standard of living as of 2013.”

Further concerns are illuminated as Entrepreneur outlines “13 Reasons Why Your 401(k) Is Your Riskiest Investment.”  Among them:

  • Potential to lose large amounts of money quickly;
  • Administrative fees;
  • Deferred taxes inhibit participation; and
  • “Easy targets for estate taxes.”

Despite these perils, Bloomberg notes “This Retirement Investing Tool Might Actually be Working” as target-date funds grow in popularity. Currently, more than half of 401(k) savings land in target-date accounts and it is expected that by 2019, $2 trillion, or 88%, of all savings will be earmarked for target-date accounts.

Investors typically do better riding the waves of the market in such accounts, but fees are a concern, along with the possibility investors might dump such strategies in down markets.

‘When I was having that alphabet soup, I never thought it would pay off.’—Vanna White

Consumer use of and participation in 401(k) plans is noteworthy.

One in Five Investors Have Tapped Into 401(k) Prematurely,” says Gallup. In the last five years, 21% of plan participants have taken a loan or early withdrawal; “troubling signs… 401(k) plans are not intended to be accounts from which contributors can make early withdrawals.”

Fifty-five percent of consumers understand tax consequences of withdrawals “extremely well.” Five-percent understand “not very well” or “not at all.”

Ultimately, investors need help to build more appropriate emergency savings.

Meanwhile, “Millennials Flock to 401(k) Plans” as “64% more employees between ages 18 and 34 started contributing to 401(k) plans last year compared to 2013,” notes a Bank of America Merrill Lynch study.

This trend is credited to an improving economy and better job opportunities.

Consumers fail to take full advantage of 401(k) opportunities as “Americans Likely Leaving $24 Billion in Unclaimed 401(k) Company Matching Contributions on the Table Annually,” according to a study by Financial Engines.

For the typical worker, this amounts to $1,336 left behind per year; an additional 2.4% of annual income they do not take. “With compounding, this could amount to as much as $42,855 over 20 years.”

‘Success is that old ABC—ability, breaks, and courage.’—Charles Luckman, American businessman

Some employers implement strategies that boost employee savings efforts and further impact 401(k) plans.

Bank of America Merrill Lynch 401(k) Wellness Scorecard Reveals Automation, Mobility and Advice Increases Employees’ Participation in Workplace Benefit Plans.”  A study reveals 78% of 401(k) savers in 2014 that made a change in their strategies did so “by either starting or increasing their contributions.”

The percentage of those who contributed in 2014 increased 18% over 2013.

Plan simplification is part of the explanation for the increase as automatic enrollment and automatic increase strategies grew in popularity. Also, timing of messaging by employers is important as there is “a strong correlation between increasing retirement contributions and annual healthcare enrollment.”

Further, the ability to get financial advice at work and mobile access to accounts are also helpful factors.

Employer Stock in 401(k) Plans Down but Not Out,” notes Employee Benefit Adviser. For workers at large public employers, stock consisted of 11% of 401(k) assets in 2014, down 50% over the previous 10 years.

A diversity of stock options is intended to lessen investment risk for employees.

‘A goal without a plan is just a wish.’—Antoine de Saint-Exupery, French writer

Changes to 401(k) plans are on the horizon.

The Atlantic asks “Can 401(k) Plans Be Improved?” The answer seems to be “yes” as the article compares U.S. retirement planning with that of other countries and suggests lenient American policy toward withdrawals contribute to problems with retirement readiness. Changes to lessen this flexibility might be helpful.

Also, an article at The Street says guaranteed income is a big incentive for retirees, and “the Department of Labor and the U.S. Treasury Department (are) really pushing, emphasizing, blessing—making it easier to have annuities inside of qualified plans, 401(k)s.”

And, with implications possibly better or worse for consumers, U.S. News and World Report notes “Six Ways Employers Plan to Change 401(k) Plans,” including fewer investment choices, Roth options, the addition of index funds, more auto features, higher fees, and increased communication with investors.

The 401(k) plan has fans and foes, but it seems to be here to stay as an important part of retirement savings strategies. It is prudent for workers and employers know what is required to spell out a comfortable retirement.

 LORA BRAY is an information research analyst for CUNA’s economics and statistics department. Follow her on Twitter via @Bray_Lora and visit the CUNA blogThe Research Roundup: Economic Perspectives.