The 401(k)'s Twin Villains

Too many workers have no plan, and many others aren't contributing enough, says Ernst & Young's William Arnone

By Ellen Hoffman

With fewer companies offering pensions, and Social Security meeting less than 40% of most people's post-retirement needs, 401(k) plans are an increasingly important source of income. Yet 401(k)s are plagued by problems that could undermine the future financial security of millions of workers. William Arnone, a partner in the Ernst & Young human-capital practice, says businesses and workers alike need to make "behavioral changes" in the way they manage 401(k) plans -- some of them potentially drastic.

In a talk at a recent meeting of the National Academy of Social Insurance (NASI), a nonprofit, nonpartisan research group in Washington, D.C., and in a subsequent interview, Arnone gave his views on the major problems and possible solutions. Here are edited excerpts of my conversation with Arnone.

Q: What are the basic problems you see with 401(k)s?


First, too many people aren't in the game. [According to the Census Bureau, in 2002, about 43% of full-time workers age 21 to 64 weren't participating in any type of employer-based retirement plan.] And many of those who do have an account aren't contributing enough. That group includes both employees who put in only enough to get the employer match, and those whose contributions are too small to get the full match.

Q: You've also said employees don't do a very good job of maximizing their 401(k) investment opportunities. Can you explain?


Common problems are lack of diversification, overlapping investments, or relying too heavily on company stock. To make it worse, most workers then don't bother to read their quarterly or even annual statements and don't realize that the balance of investments in the account is no longer in line with their asset-allocation goals.

Q: In your address, you mentioned taking loans and lump-sum withdrawals as other signs of mismanagement. What are the pitfalls?


Taking a loan from your 401(k) -- say for a down payment on a home -- can be a good decision in some cases. But you shouldn't do it unless you understand the true cost. The conventional wisdom is that since you're paying the money back to yourself, the loan is a bargain. But let's say you take a loan of $10,000 and pay it back to your 401(k) account with 6% interest. In a good year in the stock market -- like 2003 -- that $10,000 might have earned a 20% return.

The lump-sum problem is that too often -- especially if they're changing jobs -- employees fail to roll the money into an IRA, and spend it [instead] on something other than their retirement. They lose the long-term value of compounding growth [as well as generate tax problems].

Q: The knee-jerk reaction among most experts is that employers should offer more and better financial education.


I've been working in this field for years, and I don't think the brochures and pamphlets, periodic seminars, and online tools that most employers offer are enough.

Q: What needs to be improved, quality or quantity?


Employers need to set up broad-based, targeted programs that allow employees to choose and use whatever learning tools work best for them. These include some fairly traditional solutions: Computer tools for automatic rebalancing of investments or providing a smorgasbord of different teaching and learning options.

The key here is to offer a range of options -- not just assume that an annual workshop will do the job for everyone.

Q: These are still fairly traditional approaches. What are more innovative alternatives?


Employers already have access to data on their employees' accounts. With monitoring, employers could identify employees who are not contributing up to the match -- or at all -- and send them a note suggesting that maybe they talk to a financial planner for some advice. Maybe the employer would even offer to pay for a telephone session with a financial planner.

Another strategy would be to review issues such as 401(k) plan contributions as part of an evaluation of the employee's job performance.

Q: Those last two suggestions may be too Big Brother-like for many people, employers and workers.


The key is to tell your employer what type of help or information would work for you. In my consulting with employers, they tell me: "My employees aren't asking [for help with their accounts]. They're not calling the human resources department and telling them, 'I can't do this myself.'"

Q: Isn't cost a big issue for employers, regardless of what type of approach they take?


Sure. I know of a company with 140,000 employees that rejected a proposal to spend about a million dollars -- $7 per worker -- for a financial-education program because it was deemed too costly. If your employer says he can't afford to provide good financial education, then employees should get their priorities in place and offer to give up something in return, such as the holiday party.

Q: So it still comes back to employees having to take more responsibility -- knowing what they want and asking for it?


That's absolutely right. Employees who do may be surprised at the answer. And they may be doing themselves a great big favor they'll appreciate throughout their retirement.

In addition to writing Your Retirement for BusinessWeek Online, Hoffman is the author of The Retirement Catch-Up Guide and Bankroll Your Future Retirement with Help from Uncle Sam. You can contact her through her Web site,

Edited by Patricia O'Connell

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