In 1990, about $384 billion worth of assets had been saved in 401(k) plans. By 1996, the number surpassed $1 trillion. The mutual fund industry flourished with all the new business.
In the meantime, companies rolled back their pension plans.
‘If you want to drive a car . . .’
Let’s say a worker making $50,000 contributes 6 percent of her annual salary with a 3 percent employer match. By the time that person retires, she should have about $320,000 saved up, according to calculations by Munnell. But reality rarely plays out that way. People forget to enroll, or they don’t save enough, or they wind up withdrawing money to cover a financial emergency. The result: Individuals nearing retirement have closer to $78,000 saved, according to the Federal Reserve’s Survey of Consumer Finances. (And that number is rosy; the last regular survey was done in 2007, just before the financial crisis.)
“The old-style 401(k) before automatic enrollment came along was basically telling people, ‘If you want to drive a car, you have to be able to repair it and maintain it yourself,’ ” said William Gale, director of the Retirement Security Project at the Brookings Institution. “If the 401(k) is supposed to be the primary retirement vehicle for the average American worker, then it needs to be consistent with the information and financial ability of the average American worker, who is just not prepared to manage funds like that over the course of a lifetime.”
Whatever the 401(k)’s flaws, freedom has been a selling point as people work at multiple companies in their careers and need to move their retirement savings with them.
“I think there’s a reason people do tend to like these things,” said Peter Brady, senior economist at the Investment Company Institute, a mutual fund industry group. “They much better match up to people’s work histories . . . and I think they like having control over their investments.”
Some of the fixes proposed involve diminishing the do-it-yourself nature of the 401(k), or at least nudging people toward better decisions.
The Pension Protection Act of 2006 paved the way for companies to offer automatic enrollment in 401(k) programs. Many firms have also added automatic annual increases in how much employees contribute. Half of the companies surveyed by the Profit Sharing/401(k) Council of America in 2010 offered automatic enrollment. Of those, about 40 percent also offered automatic increases.
Many companies automatically enroll their workers to contribute roughly 3 percent — more than they might save if they didn’t enroll at all but probably not enough to build a secure nest egg.
This year, the Treasury Department offered new rules that would make it easier for employers to offer annuity options to workers who are retiring. This way people are not left having to manage a lump sum but can instead count on a steady stream of payments.
In a way, these changes try to bring the best features of pension plans — their steadiness and predictability — to the 401(k).
“It’s kind of like we ran all the way to the cliff to D.C. [defined contribution] and then looked over the cliff and decided to make them more like D.B. [defined benefits],” Gale said.
Gale predicts that in the future there will be “hybrid” systems in which employers are still leaving much of the retirement saving to workers but plans are less overwhelming to manage.
At the core of any reform, Munnell said, there has to be massive education of employees on how to plan for retirement. Many people think that saving 6 percent with a 3 percent match, for example, is enough. Not so, according to the Center for Retirement Research.
As a baseline, the group estimates that a household earning at least $50,000 needs roughly 80 percent of its earnings to maintain its pre-retirement lifestyle.
To pull that off, a person who is 25 and earns $43,000 needs to be saving 15 percent a year in order to retire at 65, assuming a 4 percent rate of return on his investments. Wait until 35 to start saving, and the necessary savings rate creeps up to 24 percent.
The solution for many people, Munnell said, will be to work longer. If that 25-year-old doesn’t retire until 70, he would only have to save 7 percent a year.
“Our whole retirement system’s too small,” Munnell said. “When you put together Social Security and these 401(k) plans, it’s just not going to provide enough for retirement income. . . . The question is, can you fix it by fixing the 401(k)s?”