Report on the Status of 401k Plans

The Center for Retirement Research at Boston College recently issued a chilling report tracing the evolution of 401k plans, the substantial progress achieved with changes included in the Pension Protection Act of 2006 and, finally, the devasting impact of the 2008 market collpapse. Conclusion: The time has come to return 401k's to their original place as a supplemental (rather than primary) retirement funding vehicle.

Anyone pondering the status of their 401k in the current market or how we got to this point should consider reading this research brief.

401k's were never intended to serve as workers main retirement income source. Rather they were meant to supplement social security and traditional corporate pensions - a personalized retirement savings program serving as the third leg of a solid three-legged retirement funding stool. As personalized accounts, 401k owners were given nearly total control over key decisions like whether to participate, how much to contribute, where to invest funds, and when and how to cash out.

In the 1980's and 1990's, two unforseen trends emerged. First, more and more corporate pension sponsors came to view the 401k as a convenient way to get out from under the risks and obligations associated with running a traditional pension plan. By 1995, the 401k easily surpassed defined benefit pensions as the principal retirement plan for most workers.

Second, it became apparent that far too many 401k plan participants were not equipped to make prudent decisions about participation, contributions, investments and withdrawals crucial to 401k planning success. Inertia caused workers to make no decision at all resulting in low 401k participation rates and overly conservative investment choices.

The Pension Protection Act of 2006 was enacted in response to the growing importance of 401k's and the mounting evidence that too many workers/participants weren't making good choices. PPA brought about key 401k reforms like encouraging employers to automatically enroll workers in 401k's, automatically increase contributions and provide default investment programs like target date funds to ensure participant investments aligned with long-term retirement goals. It was hoped that the PPA reforms would make 401k's a more effective tool for providing retirement security to workers.

The CRR report finds that by 2007, the PPA reforms were having their intended positive effects:

Historically, poor decisions have led to low 401(k) balances. The 2007 SCF suggests, however, the steps taken to make 401(k)s easier and more automatic have led to somewhat better outcomes.

Unfortunately, the current financial crisis has largely cancelled out the gains from PPA and has called into question the ability of 401k plans to effectively serve as the primary retirement funding vehicle for millions. The CRR report highlights three key areas impacted by the finacial crisis:

401k Balances - Actual vs Simulated (Ideal) - Before Current Crisis

• Decline in 401k Account Balances - The report estimates that the average 401k balance for households nearing retirement (age range 55-64) declined from $78,000 to $56,000 between October 2007 and October 2008. Sadly, since then, things have only gotten worse.
• Elimination or Reduction in Employer Matches. - Numerous employers have cancelled or reduced matching 401k contributions in response to the financial crisis. In most cases, this is seen as a short-term response to economic conditions. If this becomes a long-term trend, fewer workers will choose to participate in 401k's. Workers who do participate without an employer matche will find it exceedingly difficult to achieve a secure retirement.
• Increase in 401k Hardship Withdrawals - As economic conditions have worsened, more participants have sought hardship withdrawals from their 401k to stave off home foreclosure and other pressing financial needs. Withdrawals severely erode 401k savings and workers' future retirement security.

All in all not a healthy picture. The CRR report is avaiable for free (just click the thumbnail image above) and is highly recommended reading for anyone wanting to assess the status of their 401k retirement plan in the current market.