Although the Pension Protection Act of 2006 has gone a long way toward addressing many of the issues plaguing the defined contribution system, a report from State Street Corp. said that more has to be done to ensure participants adequately save for retirement.

Because the shift to defined contribution plans as the dominant retirement savings model is a fairly recent development, it would be safe to say that the program is still undergoing some growing pains. In other words, many of the improvements made by the passage of the Pension Protection Act are works in progress.

For instance, both auto enrollment and the creation of qualified default investment alternatives, such as target-date funds, have been mostly seen as steps in the right direction for helping workers build their retirement savings. And yet, the recent market downturn has exposed flaws in the system.

One of the major challenges facing the 401(k) model has been a lack of participant education, which is especially critical for a system in which investment responsibility has shifted so heavily to the individual. This has been especially glaring when it comes to asset allocation. State Street [STT] cited a study by the Employee Benefit Research Institute which found that nearly one-quarter of 401(k) plan participants aged 56 to 65 had more than 90% of their accounts balances in equities at the end of 2007.

Along those lines, target-date funds have come under scrutiny from the Securities and Exchange Commission because of how they’re structured and marketed. Target-date funds experienced an average 23% loss last year, according to Ibbotson Associates. An inadequate allocation of equities within these funds has been blamed.

“DC plans need to focus on the proper asset allocation,” said Lee Jones, a senior vice president at State Street. “Target retirement date funds get at that somewhat but their construction needs to be looked at in the wake of the market pullback in 2008. Do we need to construct them differently and benchmark them differently?”

Jones said that companies are starting to better understand the target-date funds they are using. Custom retirement date funds are also popping up in some of the larger plans. These give plan sponsors the ability to select from a wider net of asset classes, as well as more flexibility in selecting managers.

Another significant challenge facing 401(k) participants is the savings rate, Jones said. Although auto enrollment has helped boost participation, younger workers have historically participated at a lower level.

Jones said that they should be participating earlier in order to get in on the growth rates. Also, workers need to be more active participants in the development of their plans. If, for example, their company matches at the minimum 3% savings rate, that will not be adequate long-term to sufficiently replace savings during retirement.

“Employees at the end of the day have the ultimate responsibility to make sure the aggregate savings rate will be sufficient,” Jones said.

He added that participants also have to look at utilizing certain income replacement vehicles in retirement so they don’t outlive their savings amount. There has been very low participation in annuities because people don’t understand them and they can also be expensive, Jones said.