Mats Silvan—Getty Images/Flickr Open
By Ian Salisbury
September 16, 2014

It’s no secret that America’s 401(k) system has a few flaws. But a new paper from the Boston College Center for Retirement Research shows just how far the system may be falling short.

The research, based on triennial survey data collected by Federal Reserve economists, found that the typical 401(k) balance for middle-income Americans preretirees—those between 55 and 65—was just $100,000. Based on current annuity prices, that amount would give you a retirement income of only $500 a month, a sum that would be eroded each year by inflation. Since “the typical household holds virtually no financial assets outside of its 401(k),” as the study notes, the average 401(k) plan isn’t likely to provide much of a supplement to Social Security.

That’s not what was supposed to happen. If the 401(k) system had worked as well in reality as it did in theory, those same workers would have $373,000 saved, or $273,000 more, according the study.

To reach that figure, researchers assumed a middle-income worker who turned 60 in 2013 began saving in 1982, at age 29. The worker contributed 6% to his or her 401(k) while receiving a 3% company match and invested in a portfolio split evenly between stocks and bonds—all seemingly reasonable assumptions.

So what happened to that missing $273,000?

The answer is that 401(k) balances have been eroded by a combination of unnecessary fees, poor plan design, and bad—or perhaps just desperate—decisions by savers.

Here’s where the money went:

Fees: As the Center’s illustration shows, a big chunk of that missing money, some $59,000, went to Wall Street. The study’s analysis was based on the average fee paid to portfolio managers who oversee 401(k) mutual funds. Clearly, fund managers need to be paid something. But 401(k) investors are almost certainly being charged too much. Across the 401(k) universe, the average stock fund investor hands over fees amounting to 0.74% a year to fund managers, largely because they’re invested in actively managed funds. By contrast, the average stock index fund costs just 0.12%. The upshot: Most of that $59,000 is unnecessary cost.

Withdrawals: Another $78,000 is lost to so-called leakage—essentially, investors yanking money out of the plan. The Center for Retirement Research cited another study by Vanguard Group, which found that on average Vanguard plans leaked about 1.2% of assets a year, although that figure may be low, since Vanguard tends to work with large plans with wealthier employees who are less likely to cash out. It’s difficult to tell why investors aren’t sticking with the program. But it appears that roughly half the time investors simply cash the money out, while about a quarter of the time they qualified for a “hardship withdrawal,” such as a medical or housing expense.

Inadequate saving: Finally, there’s the problem of investor behavior. Most workers don’t save enough, or make “intermittent” contributions. Others failed to sign up or lacked the opportunity to do so, especially earlier in their careers—the “immature” system problem. Congress attempted to boost savings rates with the 2006 Pension Protection Act, which made it easier for employers to default new workers into 401(k) plans. As a result, many young people entering the workforce today are enrolled automatically. But there is still room for improvement. Many plans start workers saving at just 3%, not the 6% or higher rate that would lead to a larger balance—perhaps as much as $373,000.

What to make of all this? It looks like Wall Street, workers themselves and the design of the 401(k) all share part of the blame. “Surely, the system could function more efficiently,” the Center’s study says. Hard to argue with that.

More on 401(k)s from MONEY’s Ultimate Retirement Guide:
Why Is a 401(k) Such a Good Deal?
How Much Should I Put in My 401(k)?
How Should I Invest My 401(k)?

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