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Are Americans Really Able to Manage Their 401(k) Plans?

A noted retirement authority sees a way to make these plans work better — harness the power of inertia

By Alicia H. Munnell

When 401(k) plans began in the early 1980s, they were viewed mainly as supplements to traditional pension plans. Since 401(k) participants were presumed to have their basic retirement income security needs covered, they were given substantial discretion over 401(k) choices, including whether to participate, how much to contribute, how to invest, and when and how to withdraw the money.
Since then, 401(k)s have evolved into most employees’ primary or sole retirement plans. So employees now shoulder all the risks, and they must make smart decisions for these plans to work out well.

Employees' 401(k) Mistakes

But they don't always do that. In fact, employees make mistakes with their 401(k)s every step along the way. Specifically:

  • About 20 percent of employees do not join the plans.
  • More than 90 percent don’t contribute the maximum amount.
  • About 40 percent do not diversify their 401(k) investments.
  • Many overinvest in their company stock.
  • About 40 percent cash out of the plans when they change jobs.
  • Many don't contribute enough money to receive the company match, when that is an option.

The result? Employees’ 401(k) balances end up way below their potential. 
The Retirement Shortfall

In theory, a typical worker who ends up at retirement with earnings of slightly more than $50,000 and who contributed 6 percent of pay steadily to his or her 401(k) with an employer match of 3 percent should have about $320,000 in retirement savings. In reality, the typical individual approaching retirement has only $78,000 in these savings. (These amounts include holdings in Individual Retirement Accounts because the balances consist mostly of rollovers from 401(k) plans.)
Clearly, as the sole retirement savings for most American workers — their only supplement to Social Security — 401(k)s are falling short.
How to Improve 401(k) Plans 

An important policy goal, therefore, should be to make 401(k) plans work better.


One way to do this is by harnessing the power of inertia.
Studies have shown that requiring workers to “opt out” of a plan rather than offering the traditional requirement to “opt in,” can significantly increase 401(k) participation rates. In other words, telling an employee he needs to explicitly choose not to invest in his 401(k) will make him much more likely to save for retirement than telling him he has to decide whether to contribute to the plan. The Pension Protection Act of 2006 provided incentives for companies to add automatic enrollment to their plans.
But automatic enrollment alone does not result in adequate 401(k) savings, because it can lock people into contributing modest amounts to the plans.

The typical default contribution rate is 3 percent of pay, and left on their own, many people would continually invest at this low level. More employers should offer automatic increases to employee contribution levels.
What Employers Don't Offer

Fewer than half the large firms have adopted automatic enrollment for their 401(k) plans, and most apply this provision only to new employees (as opposed to doing a one shot re-enrollment of all current workers).
Moreover, only about a third of the firms with this type of plan automatically increase the percentage of pay that employees contribute annually.
The reason for the slow pace of adoption of such automatic provisions may be that boards of directors only see the added cost of the employer match and not the benefits of additional retirement savings for employees.
Don't Make Saving Optional

One way to get Americans to save more for their retirement would be to make automatic enrollment and automatic contribution escalation provisions integral parts of 401(k) plans.

That's right: The time may have come to make the automatic provisions automatic.      

Alicia H. Munnell is the Peter F. Drucker Professor of Management Sciences at Boston College’s Carroll School of Management and director of the Center for Retirement Research at Boston College. Previously, she was a member of the President’s Council of Economic Advisers, assistant secretary of the Treasury for economic policy and senior vice president and director of research at the Federal Reserve Bank of Boston. Munnell co-founded the National Academy of Social Insurance. Read More
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