Workers discover 401(k) plans are failing them in retirement

Brian J. O'Connor / Detroit News Finance Editor

If you're one of the more than 66 million workers covered by a 401(k) retirement plan, Nancy Hwa has some news for you.

"It was a tax shelter for end-of-the-year bonuses for bankers," says Hwa, spokeswoman for Retirement USA, a group working to improve retirement plans. "The 401(k) was never even intended to be a retirement plan."

And now, many workers are discovering, it isn't.

By the end of last year, the average 401(k) balance dropped to $57,200, down 28 percent from $79,600 in 2007, according to consulting firm Hewitt Associates. Forty-four percent of workers lost at least 30 percent.

Meanwhile, the study found, hardship withdrawals increased by 18 percent in 2008, meaning workers pulled money out of their accounts, even though they had to pay taxes and a 10 percent penalty. Another 23.1 percent of 401(k) savers had to borrow money from their accounts.

At the same time, more than 200 employers -- including all of Detroit's Big Three automakers -- cut matching contributions to more than 700,000 workers in 401(k) plans since 2007, while any of the 14.9 million unemployed workers who had 401(k) plans when they lost their jobs also lost their ability to continue investing in those retirement accounts.

That's the case for Suzette Heathcote. In her mid-40s, the Northville woman worked in property management and computer systems, before becoming unemployed for more than a year. She and her husband, who also lost his job, have cut their expenses, even renting out their home and moving into one of several investment properties they own. Even so, Heathcote found herself taking money out of her 401(k) to keep from losing those homes.

"I'm just raiding my account to shore up another asset," Heathcote said. "That's my only option at this time."

She's working again, but with no match at her new firm, she's not contributing to her employer's 401(k) plan. Instead, she hopes to eventually get her retirement money back out of her properties -- if she keeps them.

"Nobody is set up to handle this kind of tsunami," she says. "Hopefully I can hang on longer than my 401(k)."

Most accounts worrisome

Even before the financial meltdown, financial planners, retirement advisers and public policy experts were citing proof that when it came to providing for any kind of meaningful retirement nest egg, 401(k)s and similar accounts weren't working.

At the end of 2006, with the Dow Jones index above 12,000 and booming toward its 14,165 peak the next October, half of private-sector workers in 401(k) plans had account balances of less than $25,000.

A figure like that might not be quite so worrisome, since it can include many young workers just starting out with their investments. But half of the workers with less than 10 years to go before hitting the traditional retirement age at 65 had nest eggs of less than $40,000. Over the course of a typical 20-year retirement, that would yield $204 a month, before taxes -- and before the stock market crashed.

"That's good for dinner and a movie but it's not retirement support," says Teresa Ghilarducci, economics professor at New York's New School for Social Research.

"The 401(k) system looks good on a spreadsheet when you assume that you save only for retirement and do it for your whole career, but real life isn't a spreadsheet," says Ghilarducci. "There's not any other country that has relied on a voluntary system of retirement savings. The 30-year experiment with do-it-yourself pensions is a failure."

Ghilarducci and other critics point to several key failings of the patchwork system of 401(k), 403(b), ESOP, Keogh, IRA and other plans in the alphabet soup of retirement investing.

Too little invested

Workers don't start saving early and don't save enough. According to the Hewitt study, 72 percent or more of eligible workers older than 30 participate in their 401(k) plans, and nearly 80 percent of workers 50-59 contribute, but only 57 percent of those 20 to 29 years save in their plans.

For a 401(k) plan to provide significant retirement assets, financial planners say workers need to contribute 10 percent of their salary, plus any employer match, for most of their careers and starting as early as possible to compound their gains. Younger workers barely save more than half that, contributing just 5.2 percent last year, Hewitt found. Even older workers fell short, putting in just 9 percent.

"You have to figure out how much you should be saving and have a financial goal," says Bill Schultheis, author of "The New Coffeehouse Investor: How to Build Wealth, Ignore Wall Street, and Get on with Your Life."

"You're asking too much of investors to figure out how much money they need in retirement when they're 25, 35 or 45. I am an adamant believer that the 401(k) is going to be one of the biggest debacles in our history."

One big mistake is when workers don't put in enough money to claim all of their employer's matching contributions. Typically, an employer may match 50 percent of a worker's contribution up to 5 percent of the worker's salary. Not contributing up to that level is the equivalent of passing up free money and a guaranteed 50 percent return on the worker's investment. Nonetheless, in 2008, Hewitt found 28.4 percent of participants contributed below the company match threshold.

The wrong investments

Workers are on their own to make investment choices from limited plans with big hidden fees, often making bad decisions.

Many 401(k) investors last year bailed out of stocks, often the day after big market drops, Hewitt found, with nearly 20 percent of investors switching their assets -- all getting out of stocks. This means they locked in losses, selling low after buying high during the run-up of previous years.

Investors are making other bad choices, too. Fidelity Investments, a large 401(k) provider, reported that at the end of June, more than a quarter of plan participants in their 50s either held all stocks or no stocks in their accounts. Those with no stock risk have too little growth to produce real gains after inflation, while the all-stock investors risked big losses just as they need to lock in profits before retirement.

"There are too many investment choices and exorbitant, indefensible fees," says Dan Solin, author of "The Smartest Retirement Book You'll Ever Read." "People are forced to make choices in such a way that it is almost impossible to put together an intelligent portfolio."

Money leaks out

Workers consistently erode their savings through loans and withdrawals before retirement. When workers change jobs or are laid off, they may cash out of a plan with a small balance after only a few years, or some plans send a check instead of rolling the money into a retirement account that would preserve the money's tax-deferred status.

Either way, workers get hit with income taxes on the money plus a 10 percent penalty if they're younger than 59 1/2 . If they're using the money to buy a first home, they can escape the penalty, but the money plus taxes still is out of the plan instead of earning long-term gains.

At other times, workers who've hit hard times tap their accounts to stay financially afloat. The Hewitt study found nearly 6 percent of workers took money out of their plans in 2008, while hardship withdrawals were up 18 percent for the year.

"The worst thing you can do with the plans is to cash them out or take an early withdrawal," Solin says. "This is supposed to be funding your retirement. If you dip into it now, you're going to pay later."

Loans from 401(k)s also lower returns, financial planners note, because the money is taken out of stocks and put into low-interest loans to the account holder. The money can be sitting on the sidelines during a big stock run-up, such as the 27 percent gain the shares of blue-chip firms have returned since the end of March.

Last year, Fidelity found, nearly one in four workers in their 30s and 40s had a 401(k) loan, with more than 10 percent of Fidelity account holders taking a new one. Some workers in that age group seem to use their accounts as revolving lines of credit -- close to one-third of account holders who took out loans in 2007 took them again in 2008.

"I think those provisions make a lot of sense," says Byron Beebe, U.S. retirement market leader of Hewitt Associates. "But I think we have people who are using the plans as a Christmas account -- they pull money out every January and February to pay off Visa."

• Other problems: As workers change jobs, they can't immediately start saving in a new 401(k) plan, and if they're laid off, they not only can't contribute but don't have income to save anywhere else. Workers who switch jobs after a few years often lose money in the employer match, which frequently doesn't vest until three or five years of participation in the plan.

Finally, older workers, who tend to put the largest amounts aside in the years right before their retirement, are prime targets for buyouts or may get sick or have to tend to an ill loved one, stopping work before they planned and left unable to earn and add money to their accounts.

Another danger in relying on 401(k) plans is simple bad luck: Workers who have the misfortune to retire at the wrong time in a business cycle can lose as much as three-quarters of their account value by retiring in the wrong year. A study from the Brookings Institute found that a worker who saved for 40 years in stocks could have retired and replaced 90 percent of his income -- if he quit in 1999. But another 40-year hand retiring in 2008 would barely replace 25 percent of his pre-retirement income.

Doing right things difficult

All this is not to say that disciplined savers who make the right investment choices and educate themselves can't build a successful retirement with a 401(k) or similar plan, notes Ted Lakkides, a certified financial planner and director of Cygnet Financial Planning in Waterford.

"The short answer is that people can achieve satisfactory retirement if they do things the right way," Lakkides says. "But they don't know how to do things the right way."

Even doing all the right things means retirement savers still must trust to the fates that they'll dodge a layoff, illness or other financial calamity, as well as stock market meltdowns.

Patti Hallendy worked at General Motors Corp. for more than 37 years before she took a buyout in 2004. The buyout paid half her old salary for two years. The Holly woman planned to work more, but found few options, and was too young to draw her pension.

"Five years later, I'm 62 and I've not been able to find a job," Hallendy says. "I really had to scale back. Now I know what it's like for people who don't know where their next dollar is coming from."

She started taking Social Security as soon as she became eligible, but she's holding on to her GM 401(k) in hopes it will regain value -- or if things get worse.

"I lost a lot of money in the stock market and my GM stock is almost all gone," she says. "I'm trying not to touch that money so that if anything happens, I can still make my house payments."

The point, says Eric Bachman, CEO of Golden Gateway Financial in Oakland, Calif., is that for most working people, a 401(k) account is better than nothing -- but still not nearly enough.

"There's a huge percentage of people who haven't done enough to put money away, but the people who have 401(k)s and invested regularly, you'd think those people should be better off," Bachman says. "Given the circumstances, they're really not."

boconnor@detnews.com (313) 222-2145