A real retirement plan crisis

(MoneyWatch) The state of retirement savings in America is in big trouble. According to Fidelity Investments, the average 401(k) balance among its 11.8 million accounts increased to $74,600 at the end of the first quarter 2012, a 62 percent increase since the end of the first quarter 2009. While it's good news that balances are up, the number of accounts is alarmingly low for such an industry giant.

Older employees are better off, but not by much. Workers over age 55 have about $130,000 saved on average, and, for those over 55 who have been active in a plan for 10 years, that average jumps to approximately $230,000. That's certainly an advantage for plan participants, but even this group may not accumulate what is necessary to maintain their living standards.

The reason for the trend is obvious: The recession and market crash inflicted pain on retirement accounts, lopping off about a third of their total value. Additionally, as many families sustained job losses and lower incomes, they were forced to withdraw retirement funds or reduce contribution levels. Even before the tough times hit, Americans never quite grasped how important it was to contribute to their 401(k) plans.

There are some who wag their fingers and scold plan participants for not being more diligent savers, but the larger issue may be that U.S. workers were sold a bill of goods when 401 (k) plans were introduced. "It has already become clear that 401(k)s have failed millions of Americans," said Karen Friedman of the Pension Rights Center in Washington, D.C. in The Week.

The root of the failure was the move from employer-funded pension plans to employee-funded retirement plans, which equated to a massive transfer of risk for American workers. Instead of the company bearing 100 percent of the retirement funding burden, the advent of 401(k) plans meant that employees became primarily responsible for their own retirement saving. Check out this interview with Charles Osgood on the topic:

401(k) plans were created in 1978 but gained popularity after benefits consultant Ted Benna interpreted paragraph (k) of Section 401 in the U.S. tax code as a means for his corporate client to change compensation for its employees. Benna's discovery allowed executives to use a tax-deferred savings vehicle alongside their corporate pension plans.

In their original iteration, 401(k) plans were designed to supplement pensions, not replace them. Companies quickly realized that they could supplant pensions with 401 (k) plans, relieving them of the funding burden that pension plans imposed. This is when things got tricky.

During the transition period, it's unlikely that HR departments sent out a note to employees saying, "Hey, instead of your boss paying into a guaranteed retirement plan, the risk of making contributions and managing your retirement money is entirely on you." Instead, companies emphasized how great it was that workers could take control of their retirement assets and invest however they saw fit. It certainly helped that 401(k) plans took off at the beginning of the greatest bull market in stocks since World War II.

Despite the ups and downs of the market, the trajectory was generally up, which meant most participants were happy. The Great Recession and market meltdown changed everyone's tune. Suddenly, it became clear that a 401(k) could be at the mercy of market cycles. If a participant is unlucky enough to experience a bear market when he/she is close to retirement, it could be too late to rebuild.

To enhance 401(k)s, we need more robust, mandatory employee education administered by a third party. Automatic enrollment has helped increase participation rates, and the use of target date funds, rather than money market funds, has improved investment returns.

I wish we could rip up the 401(k) plan and start over, but it looks like it's here to stay. With that being the case, participants should educate themselves, seek professional financial advice and guard against retiring at the "wrong time" by reducing investment risk in the five years leading up to retirement.

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