THE BLOG

The 401(k) Has Failed. Admit It

07/14/2009 06:16 pm ET | Updated May 25, 2011

Why don't we just admit that the 401(k) is a failure and get on to designing something better?

I say this as the writer of an admiring book about the ubiquitous saving plan (Take Charge of Your Future, Warner Books, 2003), and I still think that 401(k)s are fine as a supplement to other plans. But that's not what they are any more. They have become, by default, the only national retirement savings plan. That raises the bar considerably, and 401(k)s just can't clear it.

Here's what I'm not saying. I'm not saying that the main problem is that 401(k)s require ordinary people to manage their investments wisely and only we "sophisticated" investors who read Huffington Post can do that. (i have more faith in the average Joe's ability look out for himself than that--and less faith in allegedly sophisticated investors.) I am saying that even if every 401(k) participant were Warren Buffett, the plan still falls short of what you ought to expect from the nation's main retirement savings vehicle.

I am not saying that we ought to go back to old fashioned pensions, for good reason, or that you should stop funding your 401(k). You still have to save for retirement and the 401(k), flawed as it is, is the best way we've got to do that. (Especially the Roth 401(k) plan.) I am saying that we should do better. We are asking the 401(k) to play a role for which it was never intended, and we should reshape the plan to fit that role, or get a new plan. Here's what's wrong with the 401(k):

It randomly creates winners and losers. Citizens who take part in a national retirement savings plan ought to know what it takes to succeed. It matters less what the rules are than that they're fair and consistent. If you save more in the plan, you retire with more income. That would be a fine rule. If you earned more in your career, you get more retirement income. That works too. (It had better; it's the Social Security promise.)

But neither necessarily holds true in a 401(k). You could earn the same money, save the same amount, invest as wisely as an identical colleague and still wind up eating the Denny's special while your doppelganger vacations in Greece. It all depends on when in your working life the inevitable market downturn falls. If early, you'll build your nest egg by buying cheap assets and retire rich. If late, you'll find your life savings decimated when it's too late to rebuild. That's a problem. The nation's main retirement funding plan should not be a conduit for administering random acts of fortune. It should aim to alleviate randomness.

The plan leaves people poor Left to their own devices, most employees don't put enough into their 401(k)s to make a dent in their retirement needs. And even if they start out putting enough money in, when times get tough, they stop. Worse still, employers have begun to do the same. According to surveys, about a quarter of employers have stopped, or plan to stop, matching their employees' 401(k) contributions. This is happening at the worst possible time, of course: when stock prices are 40% cheaper than they were 18 months ago.

The plan exposes everyone to the risk that they'll live too long Because you don't know when you'll die, you have to save as if you were Methuselah, just to be safe. The usual financial planner's target is age 95. If you saved the fortune you need to cover yourself to that age and don't make it that far-and most people won't-tough luck. If you do live that long and you didn't save enough-and again, most don't-even tougher luck. The shame of this is, longevity risk can be insured away by averaging out the risk over an entire population. Every annuity does this. Why not the national retirement savings plan?

Congress has been talking extensively about 401(k) reform. At the moment, a bill called the 401(k) Fair Disclosure and Pension Security Act is moving through Congress. But it does nothing more than tinker at the edges of a looming disaster, acting as if lowering fees on 401(k)s by a few fractions of a percentage point will solve the massive underfunding of a whole generation's old age. Forget it. It won't. It's time to stop pretending that the 401(k) can get us where we need to go.