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7 Fatal Flaws in 401(k) Plans

The employer match is insufficient, plus six other problems that need fixing

By Paul Merriman and MarketWatch

(This article appeared previously on

Nearly a third of American households have nothing at all saved for retirement. It's also widely known that the other two-thirds of households have inadequate savings.


This is an awful state of affairs — and not just for future retirees. When a large, growing segment of the population is just scraping by, they collectively put a big strain on our common resources.

(MORE: 4 Ways to Fix the U.S. Retirement System)


Here are seven ways that America’s 401(k) plans are failing workers:



These nine equity asset classes are: U.S. large-cap stocks, U.S. large-cap value stocks, U.S. small-cap stocks, U.S. small-cap value stocks, international large-cap stocks, international large-cap value stocks, international small-cap stocks, international small-cap value stocks and emerging markets stocks.




Many employers, perhaps the majority, have established waiting periods before a new employee is even allowed to start making contributions. But that opportunity comes only after the employee has become accustomed to a paycheck that's a bit fatter than it will be if he or she chooses to join the 401(k) plan.


How's that for an incentive?



Some employers will insist on a waiting period so they don't have to pay for the expenses of establishing an account for somebody who will be gone in a few months. That's legitimate. But they can deduct 6 percent of the employee's pay anyway and put it in a bank account. When the waiting period is over, the employee can either take that money in cash or have it all invested as a start in the 401(k).



Mandatory matching would provide a powerful incentive for employees to save for their future. Companies that want to provide financial incentives in recruiting and retaining employees, could obligate themselves to match up to 100 percent of employee contributions after particularly profitable years.


This is a variation on the bonuses companies give to their top executives.


4. Employees bear the costs Top executives commonly get perks like life insurance policies, financial planning, and other company-provided services. Do they have to pay the cost of those things out of their generous salaries? Of course not!



And yet many employers make their workers pay the costs of administering a 401(k) plan, which should be treated as an employee benefit that's paid for by the company. In far too many cases, the costs paid by employees are hidden in the form of higher fees for investment funds.


Even worse, some plans offer load funds that charge sales commissions levied on every employee contribution. This may be technically legal, but it's a gross injustice to the workers, who after all are a “captive audience.”


I can't see any justification for making the employees pay a commission when high performing no-load funds are available.



6. Too much company stock Corporate 401(k) plans often encourage participants to load up on company stock. There's probably no way to stop this short of a federal law, because employers with publicly-traded stock love the steady market that's created for their shares every payday.


I have nothing against corporate loyalty, but it's too easy for employees to gloss over the very real added risk that goes along with owning an individual stock — especially stock in a company they are already counting on for wages and benefits.


7. Default options are too safe Too many plans steer contributions to low-performance investments. It's bad enough that the employee's default option in many plans is simply not to participate. But for those who do sign up, it's equally wrong to have a default option of a stable value fund that virtually guarantees the employee will gradually lose some of the purchasing power of their savings.


I think the default asset allocation should be something that's likely to make sense for most participants. Obviously a default choice should not be very risky. But a 50/50 mix of stock funds and bond funds should be easy for most employees to stomach.


I'm suggesting that only as a default option for those who don't want to be bothered making decisions — or who are too busy with new jobs to focus on their investments. Most workers can and should do better.


Paul Merriman is founder of Merriman Wealth Management, a Seattle-based investment advisory firm, and president of The Merriman Financial Education Foundation. Paul writes a weekly column for MarketWatch's The RetireMentors and records a weekly podcast, Sound InvestingHe has authored numerous books on investing including Financial Fitness Forever, Live It Up Without Outliving Your Money and the new How To Invest series available for free at Follow Paul on Twitter @SavvyInvestorPM.

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