A national 401(k) problem?

Tuesday night on PBS, Frontline did a spectacular report on the preparedness of retirees and the shift from traditional pensions to 401(k)s. I'm a big believer in personal responsibility but this report did a lot to convince me of flaws in the 401(k) system. I highly recommend that you watch the report online and check out the other supporting material (that includes this article on mistakes Gen Y are making in their 401(k) accounts) on the Frontline website.

There are key points to be gleaned from the report that can help you make the best of your 401(k) but they're really things you probably already know: start as early as possible, never take the money out, contribute the maximum, and watch your investments like a hawk.

In the Frontline report they profile two men from the same company with the same 401(k) options. One man retired with $450,000 and the other with just $52,000 which was reduced to only $26,000 after taxes and paying down debt. But why, the reporter asks, would two people with the same options fare so differently? The answer it turns out is where they started from. People with higher incomes do better with 401(k) plans and people with lower incomes do worse with 401(k) plans.

At one point in the program a consultant relates a story he often uses in board rooms. In a meeting with executives, the consultant will ask if those in the room would trust a low level employee with their personal retirement accounts. The answer of course is no but the consultant points out that they don't seem to have a problem trusting that person to make those decisions for himself.

These two examples show how important it is to start participation in a 401(k) as soon as possible, in order to weather tough times and smooth out any market fluctuations, and how important it is to make informed decisions on the investments you choose. How many stories have we heard of people putting all their 401(k) investment into company stock (think Enron) or choosing inappropriately conservative investments such as money market funds or bonds? We all like to think we're savvy but the fact is that investing is a difficult proposition.

One reason the employee with the $450,000 nest egg was successful was that he earned more than the employee who ended up with only $26,000. Since the successful man's salary was higher he could afford to invest more. For example, if someone making $100,000 wants to max out their 401(k) contribution that represents 15 percent of their income but if someone making $50,000 wants to max out their 401(k) then that's 30 percent of their income, a much harder nut to crack.

I've written before on the foolishness of taking money out of a 401(k). This is commonly done when switching jobs. Rather than take the effort to roll the former employer's 401(k) into the new one (if they allow it) or roll it over into an IRA, people simply withdraw the money and pay the tax as well as the 10 per cent penalty. That's like saving for a vacation and three months before the trip spending the money on something else. Now you've got to start all over again.

Alicia Munnell, a professor at Boston College's Carroll School of Management and the director of its Center for Retirement Research, says that even if it seems like a good idea to take the money from a 401(k), it's not, "they may even use it for something good. They may use it for further education, or they may use it for a down payment for a house, but it means it's not there when they come to retirement. So it's very discouraging. We can see this series of bad decisions that produces these small amounts of savings at retirement."

That's exactly what happened to the man profiled above who ended up with only $26,000. He and his wife, at one point, used $20,000 to send their daughter to school and $10,000 to buy a mobile home. Had they not done that, their $26,000 would have been closer to $56,000. Still not good enough but better nonetheless.

Chances are that older workers haven't had much time to build up their balances in their 401(k) plans but they also probably have some combination of traditional pension and 401(k). Younger workers, those in our 20s, 30s, and 40s have time on our side but time is only a benefit if you're doing the right thing. Time is a big detriment if you procrastinate or make common mistakes.

All of this can only lead to one conclusion, the responsibility for your well being in retirement rests solely with you and you must be careful and knowledgeable while also being aggressive enough to get the best return possible. Bloggers like myself, financial advisors and even your best friend can tell you the same thing but if you don't act on it, and start participating now, choose your investments wisely and save as much as you can afford, then it won't do you any good.

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