Twelve to eighteen months ago, a lot of people made comments, only partially in jest, that their 401(k)’s had turned into 201(k)’s.  There was talk that retirement accounts were broken and should be reformed and provide annuity streams more like the pensions received by employees of decades past.  But were the accounts themselves a problem or how employees used them?

The stock market has had an impressive rebound since March, 2009.  Arguably, most of those 201(k)’s should be at least back to 301(k)’s.  So all hope is not lost! 

Since the early 1980’s, 401(k) and other retirement plans known as defined contribution (DC) plans have been replacing company pension plans as a means to provide retirement income for employees.  Whereas a company used to set aside part of an employee’s compensation to be invested in the pension fund, today it is mostly up to us as individuals to determine how much money to set aside and how to invest it.

Some benefits of DC plans are that the investor maintains control of how her own investments are allocated and the assets can be taken with her when she leaves a job.  The income level from a pension plan is usually back-weighted to favor employees who have been with a company for a long time.  In the modern economy where most people change jobs numerous times during their career, DC plans provide flexibility to employees who can choose how much to save for their retirement and not be overly concerned about reduced retirement income due to job changes over the years.  The downside is that the investment risk is now on her shoulders, instead of the company pension plan that pooled funds and invested them on behalf of all eligible employees.

As we’ve seen recently, investing in a 401(k) is not always an easy ride.  A 401(k) is a vehicle for holding assets, not an investment itself.  Most employees invest in stocks and bonds just as they might in other personal accounts, so the risks of those investments pass through to the 401(k).  Many investors learned that they had been taking on too much risk, including the investments in their 401(k).  But this doesn’t mean that 401(k)’s are bad and should not be used going forward.  For many of us, DC plans will be our primary way to save and build wealth for retirement.

So the message is: Don’t give up on your 401(k)!  A realignment of your investments may be in order, but that is an issue regarding your risk tolerance, not an inherent problem with the 401(k).
 

*Generally, qualified withdrawals from a 401(k) are those occurring after age 59.5.  Some exceptions apply.  See your tax professional for further information.
* Past performance is not a guarantee of future results.
* The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.   It is not possible to invest directly in an index.
* Investing in stocks is subject to fluctuation such that, upon sale, shares may be worth more or less than the original cost.