How the 401(k) Became a $4 Trillion Key to American Retirement

The Fiscal Times

The great recession battered the 401(k) retirement accounts of millions of Americans – delaying or destroying the dreams of those on the verge of retirement and surprising many others who had assumed the value of their plans would keep rising – well, indefinitely.

As the stock market has recovered, average account balances have increased. With the improving economy, many employees feel they have more disposable income to invest in these accounts. But criticism of the 401(k) remains pervasive – and if the 401(k) is still the best retirement deal for many, it’s often by default. 

There are, however, key takeaways to keep in mind about the 401(k) in 2014.

Related: Retirement Savings: Men and Women Do it Differently

“The 401(k) was never meant to be the sole vehicle for retirement savings, but for the most part it kind of is – that and Social Security," says Bruce Elliott, manager of compensation and benefits at the Society for Human Resource Management (SHRM) in Alexandria, Virginia. “Pensions are either being sunsetted, outright terminated or converted to cash balance plans.”

At the end of 2012, a total of $3.5 trillion was invested in 401(k) plans in the U.S., according to the Employee Benefit Research Institute (EBRI). Sixty-one percent of 401(k) assets were invested in stocks, while 33 percent were in fixed income securities such as bond and money market funds.

Account balances have skyrocketed from January 2012 to June 2014, as a result of both contributions and investment returns, according to EBRI. For 25-to-34-year-olds with one to four years of company tenure, account balances have increased by 151.5 percent. Even for older employees like 55-to-64-year-olds who have been employed at the same company for 20 to 29 years and likely already had larger sums in their accounts, account balances have increased 44.7 percent.

Thirty years ago, most working Americans had defined benefit plans like pensions, which guaranteed a safe and secure retirement. In the 1980s, 401(k) plans ultimately displaced the pension plan as the employer retirement plan of choice.

Matching Contributions Make Sense
In recent years, an increase in the number of automatic enrollments by big companies has been a boon for Americans’ savings.

“Automatic enrollments are just a great way to get people onto a good savings track," says Benjamin Harris, a policy advisor at the Brookings Institution. “It’s not all that simple to know the best way to invest your money. So when companies take that step for these workers, I think they've gotten over the biggest hurdle."

There has also been a trend toward adopting lifecycle or target funds that enable people to invest in more fully diversified portfolios than in the past.

Related: Retirement Savings Fears Americans: “I Don’t Have Enough”

The best deal for workers continues to be matching contributions from employers. While the practice had declined during the recession, it’s made a comeback, according to Elliott. In a recent SHRM survey, 74 percent of companies said they were matching employee 401(k) contributions.

“If there is a company match for a 401(k), you can’t beat an immediate 100 percent return for a one-to-one match,” says Harris. “You can’t leave the money on the table for that or even for a 50 percent match. You won’t find that type of return on any investment anywhere.”

We Still Need More Retirement Savings
Even though the bull market has boosted 401(k) balances, it’s hardly a given that the ride will continue.

“The reality is we are going to have to save much more for retirement. That’s particularly true in an environment where many experts believe the capital market will not be providing the kinds of returns experienced over the last 40 years in the next 40 years,” says Olivia Mitchell, executive director at the Pension Research Council at the Wharton School of the University of Pennsylvania.

Mitchell says that critics complain that the bottom half of the “wage distribution” has been excluded from the 401(k) party. Many small businesses don't offer their employees retirement packages because the benefits are expensive to maintain.

Also, some employees living paycheck to paycheck don’t have the cash flow, the financial literacy, or the access to financial advice to successfully manage their 401(k) plans. While industry leaders such as Fidelity Investments and Charles Schwab offer their clients general financial advice, there’s little access to one-on-one advisors.

Related: The 401(k) Loan: America’s Pricey New Piggy Bank

“I think it is pretty impressive that the employer provides that benefit, but I think we as a society need to do a better job of educating our children and being financially responsible,” says Sarah Carlson, a private wealth manager at Fulcrum Financial Group in Spokane, Washington.

Why Borrowing Against the Future Is a Fool’s Game
A potentially troubling development in the 401(k) market has been an increase in 401(k) loans and hardship withdrawals. A May study by SHRM found that 62 percent of HR professionals agreed or strongly agreed that employees were more likely to request a 401(k) loan in 2013, compared to previous years. Forty-four percent agreed or strongly agreed that employees have been more likely to request a defined contribution savings plan hardship withdrawal.

A June study by TIAA-CREF shows that 29 percent of Americans who participate in retirement plans say they have taken a loan from plans savings, while 43 percent of those who took out loans have taken out two or more. Forty-six percent of those who have taken out loans said they did so to pay off debt. Loans can undermine retirement savings and cause investors to miss out on earnings from rising markets, the study noted.

Despite its shortcomings, though, the venerable 401(k) is not likely to be replaced any time soon.

"I don't think it will ever be eliminated because there is nothing else out there right now," says Bruce Elliott. "With defined benefit plans going the way of the dodo – the only thing left out there is the 401(k) plan."

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