8/13/2014 2:15 PM ET|
How the 401k became a $4 trillion key to US retirement
Account balances are up, and more Americans than ever are relying on 401k's for their retirement.
The Great Recession battered the 401k 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 401k remains pervasive – and if the 401k is still the best retirement deal for many, it’s often by default.
There are, however, key takeaways to keep in mind about the 401k in 2014.
“The 401k 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 401k plans in the U.S., according to the Employee Benefit Research Institute (EBRI). Sixty-one percent of 401k 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, 401k 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.
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 401k contributions.
“If there is a company match for a 401k, 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 401k 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 401k 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 401k 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.
“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 401k market has been an increase in 401k 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 401k 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 401k 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 401k plan."
More from The Fiscal Times
VIDEO ON MSN MONEY
401K has been good to me. The trick is to actually put a decent amount of money into it. I watched mine sag during the recession but also recognized an opportunity to buy more fund shares while they were "on sale" so to speak. I increased my contribution levels to the federal max back in 2005 or 2006. Yes it took some intestinal fortitude to stay the course. I kept reminding myself that my mom behaved similarly back in the 80s and managed to retire early after not seriously saving for retirement until the last 10 years of her working life.
I've watched my 401K & Roth balances more than double since the depth of the recession, and I am middle-of-the-road invested with regards to risk. I keep it properly diversified and rebalance regularly.
The added benefit of shielding the top tier of my income from current taxation is a big plus. I should not incur nearly as much of a tax hit when in retirement since the first x dollars that comes out is tax free, due to personal exemption and standard deduction.
Folks, 401ks were simply a a way for corporations to push responsibility of a pension down to the employee. Corps don't make the same level of contributions as they do to pensions and they get out from under paying defined benefits once their employees retire regardless of how the market is doing.
Employees are forced to understand investing. The basic premise of the older you get the less risk you should be willing to take should be the basis of a retirement plan. 20 somethings can afford to be in equities and intl. funds as they have the time to smooth out dips as well as peaks. 60 somethings - those on the cusp of retirement should understand that swings in the market that late in their career can be catastrophic and simply to don't have the time to smooth out those variances.
I would advocate life cycle indexed funds. Those are funds that are tied to indexes such as the SP500 etc that carry a certain amount of risks. The lifecycle funds are a basket of these indexed funds, which should carry very little in admin fees as they are not actively managed., and over time they automatically go from very aggressive to highly conservative. This allows employees to go on autopilot but allows them to capture the potential high returns of equities but slowly divest them and invest in safer portfolios. The federal Thrift Savings Plan is a great example of this structure.
401(k's) are a decent retirement vehicle IF you're fiscally/investment savvy enough and IF your employer gives you enough sound choices. (DON'T put your retirement in the hands your company's stock!) But don't be naive. They were basically devised as a way to shift the investment risk from the employER to the employEE.
I've never left my 401(k) with an employer that I've left, preferring to roll it into my own IRA. As a result, I've managed to accumulate a tidy sum that I doubt would've been the case had I not taken it with me.
The downside is your 401(k) and/or your IRA has to be actively and prudently managed and that's where many fall short.
well, from the first time I heard of the IRA/401K's, they were the "only" or "main" retirement plans. aside from the other life choices like paying off one's house.......
"""“The 401k 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"""
all the previous comments are very good and I really learnt from them. I have 401K, 457(defined compensation) and 401a from the government. I work for a state government. In addtion, i have more than $35,000 in a CD account in BA which grows little or no interest. I was advised to participate in both the 401k and 457 because they are good investments. I really dont know anything about both except that they are retirement plans. Somebody told me that investing in stock market is better than both of them. I am scared of the stock market because they rise and fall. You might lose all your money and you might gain. I hope i am in the right track.
Pensions weren't a perk. They were compensation. It was deferred, but it was money put aside for an employee for the work he/she performed. When a company eliminated a pension, it was a pay cut. Companies should have done one of two things - add what they deferred to the employee's pay check or fund a 401K with it with no requirement for the employee to contribute.
That is what would have happened if there was any truth to the myth of "shared prosperity", but the truth is employees are expenses. And those expenses need to be limited as much as possible so people who already have plenty of money can sit on their **** and make more.
It was a great transfer of wealth, from the Middle Class to the wealthy. An unexpected benefit was getting regular working people to be okay with companies cutting employee benefits because they had stock in those companies and their values went up. People were too stupid to realize they would soon be losing those same benefits. It helped Large Companies/The Wealthy divide and destroy the Middle Class.
I keep reading how the 401 is a way for corporations/employers to "get out from paying pensions" etc.etc.
WHERE is it written that an employer... of ANY SIZE owes any one a retirement???? WHO came up with that? SOME employers do it. BUT it's not law. WHAT has happened to people taking responsibility for their own lives????
Copyright © 2014 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.
Nearly half of family caregivers spend more than $5,000 a year, plus caregiving affects their jobs and retirement plans.