How to Fix the 401(k) Plan

Last Updated Sep 16, 2011 5:30 PM EDT

Despite their popularity, there's a significant problem with most 401(k) plans and other defined contribution plans. These types of plans have become the retirement plan of choice for the vast majority of Americans. They hand you a check when you retire, then wave good-bye and good luck. You're on your own when it comes to figuring out how to use that money to generate retirement income that will last the rest of your life.

This is a serious challenge, and most workers don't have the skills or training to do this properly on their own. In particular, most people overestimate how much they can safely withdraw each year so they don't outlive their money.

While some people consult financial advisors to help them with this challenge, many advisors aren't adequately trained regarding all the possible ways to generate retirement income. Many financial advisors are also compensated in a manner that tempts them to recommend products that maximize their compensation, instead of recommending the best solution for retirees. And retirees are often paying retail prices -- as opposed to group or institutional pricing --for products and services they buy on their own or through financial advisors.

As a result of the above issues, retirees relying on 401(k)s face the risk of outliving their financial resources, possibly impoverishing themselves in their later years.

The solution? Employers could add payout options in their 401(k) plan to generate retirement income. Better yet, they could adopt a retirement income menu that's analogous to the investment menus that are already available in most 401(k) plans. A retirement income menu could offer a handful of distinct methods to generate retirement income, including managed payouts, annuities, or some combination of the two. Because these methods of generating retirement income all meet different goals and objectives -- there's not one method that meets the needs of all retirees -- the menu would be accompanied by a robust communications campaign regarding the pros and cons of each method.

With the investment menu that's common in 401(k) plans, the employer does the shopping for investment options that are offered to employees, and negotiates the best deal on behalf of employees, minimizing fees and allowing employees to get institutional pricing instead of retail pricing. Why not do the same for payout options?

With a retirement income menu, the employer is the entity that is looking out for the best outcomes for its employees, with no financial stake in the decisions made by employees. By contrast, many advisors have a stake in the decisions made by their clients, through the fees or commissions that the advisors receive.

A retirement income menu would build on recent innovations and evolutions in 401(k) plans, such as the use of target date funds, auto-enrollment, and auto-escalate features, all of which are intended to improve the retirement security of employees. I firmly believe that in 10 years, most 401(k) plans will have some form of a retirement income menu -- it just makes sense.

I recently published an article with the Institutional Retirement Income Council that describes the retirement income menu concept in detail. If you'd like to see payout options added to your 401(k) plan, forward this post and my article to your employer. Many employers respond well to employee requests, and if enough of your co-workers ask for help with generating retirement income, you might get help from your employer in the near future. This action could be a critical part of your retirement planning.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.

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