The nation's experiment in putting average Americans in charge of saving and planning for retirement didn't work particularly well. Americans weren't up to the task. And so the system has given up on the individual to some degree, and--in a way--gone full circle, back to putting employers in charge.
Previously, employers did all the heavy lifting. They provided pensions, promising employees a regular paycheck at the end of their working years. In order to be able to provide it, employers had to set aside enough money for each employee and invest it wisely so there would be enough for retirees long into the future.
But it turned out to be a rather complicated task. Saving enough and investing right wasn't easy, and when companies failed to amass enough money to meet future promises to employees, the government tried to force them to shape up. So employers were anxious to get out from under the responsibility.
With the advent of the 401(k) many were able to do just that--shifting the responsibility from corporate investment professionals to rank-and-file workers. Suddenly, it would be the employee who had to figure out how much money to remove from every paycheck, and how to invest it so there would be enough stashed away once the person stopped working.
The idea sounded simple enough. The government--which didn't want people to depend too heavily on Social Security when they retired--would give people an incentive to save. Each person with a 401(k) or similar retirement plan at work would get an upfront tax break if they would forgo some of their earnings, place it in the workplace saving plan, invest it, and leave the money there to grow until they retired.
But it didn't turn out as dreamed. While employers too often flopped in handling money in traditional pension plans, employees--it turned out--would fail too with 401(k) plans.
About 2 1/2 decades into the retirement saving experiment, Americans are struggling with the responsibility of planning for their futures. Only about 17 percent have old-style pension plans compared with 44 percent in the 1970s. And they are committing investing disasters and falling far short of saving what they need to be saving.
About half of people in their 20s don't bother with 401(k) plans--even passing up free money from employers, according to Hewitt Associates. People are so confused by 401(k) plans that Hewitt found in one study of employees that 29 percent thought they were participating in 401(k) plans even though they had never signed up.
Financial Engines, a provider of 401(k) managed accounts, found that many employees who had their money deposited by employers in money-market funds let it sit for years without earning virtually any return. Given their investing approach, a $10,000 investment would be worth about $13,000 in 20 years, compared to the roughly $30,000 if they would have invested it in an appropriate mixture of stocks and bonds, said Christopher Jones, Financial Engines' chief investment officer.
Employees commit similar errors with corporate stock--overdosing on it despite well-publicized warnings after Enron Corp. employees ended up with virtually nothing after the company imploded amid allegations of financial fraud.
So with the average American within 10 years of retirement holding $55,000 in savings, and the Employee Benefits Research Institute estimating a $45 billion income shortfall among retirees in 2030, Congress stepped in to mend the system.
In the months ahead, the pension system will in some ways move almost full circle--employees can be relieved of the responsibility of investing their money.
The congressional measure encourages automatic enrollment in 401(k) plans, so employers will be allowed to pull perhaps 3 percent of employees' earnings from paychecks and invest the money in age-appropriate mixtures of stocks and bonds. And they will be able to increase the withholding level about 1 percent every year.
Employees will have the right to tell their employers not to take any money from their paychecks, or to invest it differently, but research by Hewitt and others suggests few will bother--at least, initially, when only 3 percent is involved.
So once again employers are the planners and the investors of employee retirement money. And employees don't have to take on the responsibility. But while that's starting to look a lot like the old pension system, there is one major difference.
In this new era, no one has responsibilities they don't want. Corporations have to be prudent with investments, but they are under no obligation to make sure employees end their working years with any particular set amount of income. And employees don't have the responsibility of investing 401(k) money.
But at a time when few want to take responsibility, you would be wise to take some on.
Although you still will be free to skip your 401(k) if you don't want to participate, you would be smart to put money in your retirement plan. Although you will be free to change the investments your employer uses, you would be wise to scrutinize the investments, understand what choices are right for you, and keep track of whether they are growing like they should.
So-called life-cycle or target-date funds, which will put you in the appropriate investments for your age, will be a good choice. So will balanced funds, which invest in a classic mixture of stocks and bonds.
You can recognize life-cycle funds in your 401(k) because they have a date in the name. If you plan to retire in 2025, pick the fund with 2025 in the name.
Further, if your employer brings in consultants to give you advice--another provision under the newly passed measure--go and listen. Shockingly, most Americans who are offered free investment advice by their employers currently are passing it up, according to Financial Engines' Jones.
"We have been surprised by the lack of interest," said Dan Sirdoreus, a consultant with Principal Financial Group, which provides free investment advice in some workplaces. "People say their employers won't give them time off, and they have to pick up their kids after work."
People need advice desperately. Only 10 percent of the people in 401(k) plans analyzed by Financial Engines are investing their money in appropriate investments. The rest are cutting themselves thousands of dollars short of the retirement money they could have simply by investing better--not necessarily saving more.
But also heed the need to save more. If your employer puts 3 percent of your pay into the 401(k) plan, that's a good start, but it's not going to get you to the retirement you need. Financial planners advise people to invest 10 percent of their pay during each of their working years to provide the income they will need for retirement.
Want to know if you are on target now for the retirement that you hope to have? Do a ballpark calculation at www.choosetosave.org. Or consider this: For $25,000 in annual retirement spending money, you will need $625,000 in savings. And if you are counting on Social Security to bail you out, the average person now receives about $1,002 a month.
Contact Gail MarksJarvis at firstname.lastname@example.org or leave a message at 312-222-4264.