New and Improved 401(k)s
There may be more change happening now in 401(k) plans than at any time in the 25 years since their inception.
Part of the reason is that as defined-contribution plans have become the dominant type of employer-sponsored retirement plans -- with more than 47 million participants -- it matters far more how well they work. Employees who worry they can't afford to retire, companies that want predictable turnover in the ranks of workers, and policymakers who worry about the costs of an aging population all have a stake in making retirement savings plans more effective.
In the past year or so, there have been several legislative initiatives to encourage worker participation in plans and to help improve the outcome of savings and investment. And two recent studies indicate that other changes are in the works that may help further boost participation.
One study, by the trade group Profit Sharing/401k Council of America, anticipates a major increase in the number of companies offering Roth 401(k)s, while another study found that employers are providing more generous matching funds for savings.
Until now, relatively few companies -- usually smaller ones -- have offered Roth 401(k)s, which feature different tax advantages from other 401(k) accounts. Only 22 percent of the 429 plans surveyed by the Profit Sharing/401k Council included a Roth alternative. But the survey found that 61 percent of the companies that don't offer a Roth 401(k) plan are thinking of adding one.
In a traditional 401(k) plan, deposits are made with pretax dollars. The money goes into savings, reducing your taxable income and the taxes you pay that year. You pay taxes on your contributions and the money you've made through investments when you withdraw it at retirement.
In a Roth 401(k), as in a Roth IRA, you pay taxes on the money before it is saved and then withdraw your funds, including any earnings from investment, tax-free.
Companies had been holding back because of uncertainty over whether Roth savings plans would disappear in 2011, as the law that created them had specified. That uncertainty was removed by the Pension Protection Act passed last October, opening the door for wider adoption of Roth plans.
As with the case of Roth IRAs, Roth 401(k)s might be attractive for young workers who are paying relatively low taxes now or for older workers who want some funds that they could withdraw later in life without tax consequences. And, unlike Roth IRAs, there are no income ceilings on investment in the 401(k) version.
Then there was the apparent good news from Mercer Human Resource Consulting about 401(k) matching funds. "As more and more organizations move from a defined-benefit pension plan to a defined-contribution plan, the match rates for these plans are becoming more generous," the company found. According to its survey, the number of 401(k) plans with a 100 percent match rate climbed from 26 percent of plans in 2002 to 36 percent of plans in 2006.
The study didn't look at what was being matched -- for instance whether companies were going from matching 50 percent of the first 4 percent of earnings saved to matching 100 percent of the first 2 percent of earnings, which would be a wash. But Mercer principal Amy Reynolds said that companies in fact are putting more money into the plans. "At the end of the day, there has been more of an emphasis on increasing the match," she said.
In the past, the most popular matching program among corporations was to provide 50 cents on the dollar to match employee contributions of up to 6 percent of their salary -- or a contribution equal to 3 percent of the worker's salary. Reynolds said that legislative changes have encouraged companies to adopt a new formula that provides a minimum of a dollar-for-dollar match up to the first 3 percent of salary and a 50 percent match for the next 2 percent of salary -- or matching 4 percent of the worker's salary.
Other changes, under last year's Pension Protection Act, will begin showing up this year, including initiatives that let employers offer more investment advice and make it easier to automatically enroll new hires in savings plans. Recent changes have also made it easier for companies to direct workers' savings toward balanced and life-cycle funds that provide a mix of investments for both safety and growth.
There may be more changes in the works. Concerns that participants may be paying too much in fees that aren't clearly disclosed have prompted lawsuits and congressional hearings.
Even so, while 401(k) plans may not be perfect yet, they're among the easiest ways to save for those with access to them. Many investment instruments require minimum balances of several thousand dollars, but a 401(k) lets you start small. So if you have one, use it.
If medical expenses have taken a bite out of your retirement savings and you're willing to have your name used in a column, please e-mail me firstname.lastname@example.org.