The venerable 401(k) plan has taken a lot of hits in recent years. Yet some flaws have been corrected while others are being addressed. You may not appreciate the way this retirement stalwart has evolved over three decades—or where it’s heading.
Yes, fees are sometimes excessive. The plans do not guarantee income. Individuals bear all the market risk. Guidance may be poor and performance has been lackluster. But 401(k) plans were never meant to be fool proof, or a primary retirement savings vehicle. As they have morphed into most Americans’ main account, employers have moved to address some pitfalls.
Just 10 years ago, virtually all 401(k) plans were the do-it-yourself variety. Workers picked each investment and set their own asset allocation with little or no help. Today, one in three participants gets professional management, according to Fidelity Investments, the nation’s largest 401(k) provider.
The main innovation in this area has been the introduction and swift acceptance of target-date mutual funds. A typical target-date fund has below-average costs. It is broadly diversified and adjusts asset allocation by age, starting with an aggressive mix of stocks and bonds while you are young and slowly shifting entirely to bonds by age 65 or some other retirement date.
At the end of the quarter, 33% of 401(k) participants had all their assets in a target-date fund, up from just 3% a decade ago, Fidelity reports. Younger workers, especially, have flocked to target-date funds. This one-stop solution has not only brought more of Gen Y into the savings game but also vastly improved their asset allocation from just a few years ago. More than half of Gen Y has all their 401(k) assets in a target-date fund.
Target-date funds have some drawbacks, one being that they robotically shift assets as you age—not as market moves make different asset classes more or less attractive. So as you age and build assets in a 401(k) it becomes more important to have a manager watching your back. That’s where another innovation comes into view: managed accounts.
A growing number of 401(k) providers give workers access to professional advice, usually through a call center where an adviser will help the worker factor in specific concerns and assets outside the plan to get a tailored mix of funds. There is now $108 billion in 401(k) managed accounts, reports research firm Cerulli Associates.
This is but a small portion of the professionally managed 401(k) pool; target-date funds are the biggest part. But growth is torrid. Fund firm Vanguard says 73% of new plan participants last year invested solely in a managed account and that the share will rise to 80% by 2017. Since 2009, Fidelity has seen a more than three-fold increase in employers offering managed accounts and similar growth in employees taking advantage of the service.
Professional management comes at a price. These options levy fees of .5% or so of assets—a big jump over extremely low-cost index funds, which may charge as little .1% of assets. But a lot of folks find this a fair cost for peace of mind.
The 401(k) is changing in other ways too. Before long, your plan will provide guaranteed retirement income through investment options that include an annuity, or more sophisticated insurance products that pool longevity risk and guarantee a more generous income stream. Another innovation hitting our shores from The Netherlands and the U.K. is the “defined-ambition” pension, a hybrid that will guarantee income—just not how much or exactly when you’ll get it.
So while a lot of folks want to ditch the 401(k) altogether, maybe we just need to let it evolve—faster, for sure, but there is no guarantee that whatever replaces it will work better.