After suffering by association with corporate accounting scandals and stock market losses, defined contribution retirement plans are due for a serious overhaul.
So say a growing number of financial advisers, some of whom are devising ways to "fix" the 401(k). A few would even do away with the plans altogether.
"The best course would be to eliminate 401(k)s and allow individuals a single retirement account or IRA," said Ted Seidle, federal securities attorney and owner of The Benchmark Companies of Lighthouse Point, Fla.
"Employers would be permitted to contribute to employee IRAs but would have no say as to how the account was managed," Seidle suggested.
Other observers believe employers should exercise more influence over how 401(k) plans are managed, even to the point of relieving employees of investment decisions and hiring professionals to do so on their behalf.
Morris Armstrong, a certified financial planner and head of New Milford, Conn.-based Armstrong Financial Strategies, believes all 401(k) plan sponsors should provide the option for participants to take an "in-service distribution" out of their DC plan and move it into an individual retirement account.
It's a "back-door way to get money out" of plans that may not represent the kind of investment choices an employee wants, Armstrong said. "If participants are not happy with their plan, then they can look outside the plan into the universe of IRAs, which is substantially larger."
"They [could] adjust their portfolio to diversify," Armstrong continued. "I also think it's good for the participant because if the employer does not want the participant to remove money from the plan, then they will be forced to upgrade the plan. There's going to be more market forces at work."
Armstrong generally praised brokerage windows in 401(k) plans, but said that giving 401(k) participants the right to invest in individual stocks "depends on what the window opens up to. If it opens up to high-priced, loaded mutual funds, then it's only a sales tool for the 401(k) provider."
To help participants direct their 401(k) funds more wisely, Armstrong urged stronger emphasis on investment education and advice. To critics who say employees can't be trusted to handle brokerage windows or in-service distributions in their own best interest, Amstrong retorted that such suggestions "talk down to the American worker."
Still, other financial advisors say their faith in workers' ability to invest wisely is waning.
"In the early 90s, the idea of allowing employees to self-direct their accounts was novel," said Matt Hutcheson, certified pension consultant and head of Portland, Ore.-based MDH Consulting Inc.
"I liked the idea, but as the years went on, I began to see that participants simply couldn't grasp handling their own investments.
"We have these analysts spending hundreds of thousands of hours researching different philosophies and approaches. Yet we expect an employee to comprehend their own portfolio within a very short period of time and manage it," Hutcheson said.
Compounding the problem: "Some people find it very enjoyable to deal with investments, but the majority of people don't. Most people feel like learning about that is painful. It reminds them of how much they don't have. It reminds them of how ill prepared they are. It has a negative emotion attached to it."
Hutcheson calls his solution "the target 401(k)." It would take the investment responsibility out of the hands of participants, but it would charge them with managing their contribution levels appropriately in order to have the best chance of realizing an adequate retirement income.
In the target 401(k) concept, a consultant would analyze the demographics of a plan and divide employees into investment groups based on time horizons until retirement. People who have five years or less to retire, for example, would fall into a different investment group than people who have 20 years or more until retirement. The different groups would be assigned investment return targets based on the level of appropriate risk.
Investment professionals would then direct separate investment funds for each segment of the plan population. In years when the funds fall short of their targeted return, plan sponsors could shore up lagging accounts with increased profit-sharing contributions. But in years when the funds exceed their targets, they may choose to withhold contributions altogether.
Meanwhile, plan sponsors would communicate to each individual participant the level of contribution needed for his or her account to be on track to achieve a specified level of replacement income in retirement.
"Where we have gone astray in our retirement plan consulting as an industry is being so focused on telling the participant that what they should be shooting for is a rate of return. That's not what they should be focusing on at all. What they should be focusing on is the thing they can control, and that's their contribution levels."
Dallas-based attorney Brooks Hamilton, president of Brooks Hamilton & Associates, seems to agree with that assessment. His idea for the "American Freedom 401(k)," created with financial columnist Scott Burns, places investment decisions in the hands of professionals while urging employees to participate in their plan and defer the appropriate amount of their salaries.
"The average American does not know a stock from a bond," said Hamilton, whose study of the Form 5500 filings of major corporations showed that defined benefit pensions consistently outperform 401(k) plans by wide margins. Even major providers in the financial industry "should be embarrassed by their own employee plan, according to Hamilton's analysis.
Only about 5% of 401(k) plan participants are on track to secure a comfortable retirement, in Hamilton's estimation.
Three distinct hurdles exist to securing that future, he said. The first is joining the plan. The second is contributing responsibly, and the third is achieving investment results on par with the market. In a 1,000-person company, 300 people will trip over the very first hurdle. Of the remaining 700, another 500 will trip over the second hurdle. And only 50 of the remaining 200 will make it over the third.
To help employees clear all three hurdles, the American Freedom 401(k) proposes automatic enrollment at deferral levels of 5% to 6% of salary. Each January, a feature called "$uper $aver" would increase each employee's contribution level by another 1%.
Employers would agree to ratchet up their matching levels over a period of years, until they reach a similar level of overall payroll contribution that was once associated with defined benefit plans.
Employees who decline to make a selection would have their funds invested into an aggressive strategy of "professionally directed investments" by default.
Employee plans would be fully vested immediately. All plan expenses would be paid for by the company. No "credit union"-styled loans or hardship distributions would be allowed from individual plans. Instead, employees could qualify for hardship loans from the general plan assets.
"Under the Freedom Plan, ERISA section 404(c) is out the window," Hamilton explained. "The Freedom Plan is saying: We will, by God, be responsible for market losses.'"