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401(k) Conundrum

I came across two related articles regarding 401(k)s.  One addressed the policy angle regarding 401(k)s: Why It’s Time to Retire the 401(k) and the other addressed investment strategy regarding 401(k)s: A 401(k) is Still the Best Way to Save for Retirement.  Both articles highlight the huge conundrum workers face regarding retirement savings. 

A 401(k) is an employer sponsored retirement plan that has over time replaced the pensions that many of our grandparents and great-grandparents were accustom to.  401(k)s were sold as a way to put people/workers in charge of their retirement and a great way for companies to off-load a cost.  The effect of which has been to shift the risk of retirement savings from employer to the worker. 

The article “Why It’s Time to Retire the 401(k)” was accurate with the assessment of 401(k)s

The ugly truth, though, is that the 401(k) is a lousy idea, a financial flop, a rotten repository for our retirement reserves. In the past two years, that has become all too clear. From the end of 2007 to the end of March 2009, the average 401(k) balance fell 31%, according to Fidelity. The accounts have rebounded, along with the rest of the market, but that’s little help for those who retired — or were forced to — during the recession. In a system in which one year’s gains build on the next, the disaster of 2008 will dent retirement savings long after the recession ends.

That’s a very ugly truth.  The financial crisis and the recession that followed has dug a deep hole for our retirement savings.  But even scarier is that we weren’t really saving that much even before the financial crisis:

The average 401(k) has a balance of $45,519. That’s not retirement. That’s two years of college. Even worse, 46% of all 401(k) accounts have less than $10,000.

Defenders of 401(k) say they haven’t been given enough time to produce significant retirement savings.  Sure, but the problem is that the amount of savings necessary to achieve retirement without a significant drop in standard of living may be too high:

Some people don’t contribute as much as they should — essentially ignoring free money from company matches and tax relief. And, as the original engineers of the 401(k) suspected, the less you earn, the less you are likely or able to contribute. For most employees, the maximum contribution to a 401(k) is $16,000 annually. She found that just 5% of people earning $80,000 to $100,000 maxed out, compared with 30% of those making $100,000 or more.

There are other expenses that families incur, mainly in the form of living expenses, that often crowd-out retirement savings.  Besides, even with more time there is a question whether they will be rewarding

In practice, 401(k)s haven’t been nearly so rewarding. When Boston College’s Munnell looked at the returns 401(k)s have actually produced compared with the projections, the difference was sobering. The average 55-to-64-year-old should have a 401(k) balance of $320,000. In fact, at the end of 2007, the average 401(k) of a near retiree held just $78,000 — and that was before the market meltdown.

The article alludes to some alternatives and other have been offered.  But that doesn’t help us now.  That’s the first conundrum for us.

The second article: “A 401(k) is still the best way to save for retirement” is correct in its general assessment of the situation - mainly that 401(k)s offer the best option (assuming its an option for us) for our retirement savings.  401(k)s use pre-tax income and offer the opportunity (although not guaranteed) for a contribution from our employer. 

But the problem or second conundrum is allocations.  We’ve been told that for younger workers its best to have a good portion of our 401(k) money in stocks.  For example, many financial planners will say younger workers can afford to have 60% stock - 40% bond allocation.  There are significant problems with this notion.  First, with the volatility of the stock market and riskiness of the stock market nothing should be taken for granted.  Second, studies have shown that many us are not good at changing allocations over time - meaning as we get closer to retirement our allocations should be in less risky investments but we fail to make the change. 

Is it best just to keep allocations in less risky investments the entire time?  But that does mean that we would have to save more over time in order to save enough in order to compensate for lower returns.  These are difficult choices that we have to make.  The important thing is that we make an informed choice.

Good luck.