Tuesday, November 18, 2014

Why 401(k) Plans May Not Be the Answer

Get a job. Find a new employer. Typical questions that get asked include compensation, health benefits, vacation, and do you have a 401(k) (or all too frequently, do you have a 401?)? Prospective employees usually don't ask about the 401(k) plan or about any other retirement plan, but simply want to know if there is a 401(k). Does it have a matching contribution? People don't ask.

According to a study from Aon Hewitt, 73% of those eligible are participating in 401(k) plans, but 40% of them are saving at a level below the full match level. Many of those plans have auto-enrollment, but that level of deferral is below the level required for a full matching contribution. Once people are enrolled at the automatic level, many tend not to defer enough to get a full match.

The Aon Hewitt study does not, as far as I could tell, explore why this may be. Is it a lack of employee education? Is it an inability to budget for a higher amount, especially in a time where costs of raising a family are increasing, but pay often is not? Is it a fear of the plan?

We can do the math. If a young worker (someone recently out of college, for example) participates in a 401(k) at a meaningful level throughout their career, and especially if there is a good matching contribution to go with it, those workers can eventually retire with a very good retirement income.

But, what about the ones who participate at a lower level, so that they get less than the full match? What about the ones who face temporary unemployment as so many of us do these days and may have to withdraw their 401(k) for funds to live on?

As Roth 401(k) plans have become the rage, this has become even more of a problem. While in a traditional 401(k), access to funds is essentially limited (large tax penalties) prior to age 59 1/2, in a Roth, that inaccessibility largely disappears after the employee money has been in the plan for 5 years. This means that practically speaking, Roths, for all their benefits, may be less retirement plans than their better known predecessors.

If these trends continue, 401(k)s in any form will not be the answer. In fact, for those people who are not using their plans to the fullest extent that they were intended, retirement may be nothing more than a pipe dream.

35 years ago, the answer was defined benefit plans. They provided retirement income pure and simple. But, do to Congress' ongoing efforts to protect pension plans, or so they would have you believe, that dinosaur is nearly extinct. But, 401(k)s will do the trick for only a small percentage of the workforce. For the rest, retirement planning is imperative. And, when they do the modeling, they may not like the future that they see.

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