Can We Fix the 401(k)?

Are you happy with your 401(k) plan?

According the Investment Company Institute, the mutual fund trade group, the answer is a resounding yes. In a just-released survey, the ICI found that 73% of households are “confident” that their retirement accounts, both 401(k)s and IRAs, will help them reach their retirement goals.

The ICI also found that a whopping majority of Americans (90%) are fine with the current 401(k) system, while 98% like having a choice of investment options.

But there are cracks in the system.

Sure, it’s not surprising that Americans feel better about their plans, given

the monster market rally. According to Fidelity, the typical 401(k) balance stood at $60,700 in the third quarter of 2009, fueled by market gains and investor contributions — a sharp rise from the first quarter low of $47,500. Still, the typical 401(k) account remains below its $69,200 high in 2007.

That shortfall highlights the basic problem with these plans: There’s little evidence that 401(k)s are the best way to provide secure retirement income. Sure, in theory, a worker who consistently saves in a plan over 30 years and earns a steady return can amass a sizable nest egg. But for most people, those projections are simply a fantasy. As of 2008, the median account balance for those in their 60s with 20 to 30 years of tenure stood at $135,000. For most workers, that's not enough to support you through two or more decades of retirement.

Why can’t investors do better with 401(k)s? As the Center for Retirement Research at Boston College has found, the problems lie on all fronts. You, the worker, may fail to save enough, or you may make poor investment choices. Or the problem may be your plan, which could offer lousy investments or be saddled with high costs. Even if you get everything right, you can get hurt by retiring just as a bear market hits. That’s precisely what happened to many workers in the 2008 market meltdown.

All of which has critics questioning whether 401(k)s deserve their status as the default national retirement plan. As several articles in the past year have pointed out, including Money’s “Rescue America’s Retirement” and Time’s “Why It’s Time to Retire the 401(k),” it makes sense to think about better alternatives. Among the proposals is economist Teresa Ghilarducci’s controversial plan for a mandatory national savings account on top of Social Security. And a coalition of advocacy groups supports a savings system that would be backed by government, workers and employers. So far none of these proposals have gained much traction in Washington.

Still, there is a definite push to fix the worst flaws in the 401(k). Rep. George Miller (D.-Calif.), head of the House Education and Labor Committee, has introduced legislation to improve 401(k) fee disclosure — though the U.S. Labor Department may beat him to the punch by coming out with its own fee disclosure regulations. Other proposals include legislation from Sen. Herb Kohl (D.-Wisc.), chairman of the Senate Special Committee on Aging, who would require fund companies to ensure that their 401(k) options are appropriate for workers. The Treasury Department and the Labor Department are exploring rules that would encourage 401(k) plans to offer annuity options to retiring workers.

Of course, as the health care and the financial regulatory reform efforts have shown, nothing is likely get fixed quickly. But at least the attempt has begun.