The Seven Deadly Sins of 401(k) Plans

First Deadly Sin: Lack of Education

Americans aren't saving enough. Optimally, according to Trone of the Foundation for Fiduciary Studies, the average individual should be saving 15% of his of her salary on a pretax basis -- this may come from a combination of employee-employer contributions, or fully from the individual. (For 2003, the dollar limit for 401(k) contributions is $12,000 -- that ceiling climbs to $16,000 by 2007.) A 10% savings rate might not be adequate for most workers to build a substantial nest egg, said Gerard Mullane, principal director of institutional sales at Vanguard. However, the current annual savings rate is 6.7%, according to the Employee Benefits Research Institute -- less than half the target rate. Plus, those numbers don't include workers who don't even enroll in their company plans.

While the collapse of the stock market may have investors thanking their stars that they didn't have more invested in the market, for younger workers with decades until retirement, the past few years will be a blip on the long-term radar screen. Older workers nearing retirement, meanwhile, should have had a high portion of their assets in safer investments. Meanwhile, the average account balance in 401(k) plans, excluding loans against the plan, is a mere $43,215, according to the EBRI.

Inadequate savings is the biggest booboo committed by individuals, but it isn't the only one. Many workers cash out their retirement plans when they switch jobs instead of rolling them over, meaning investors lose the vital benefits of compound growth over time. Others take loans against their 401(k) plans that chip away at retirement kitties. Furthermore, many workers make lousy investment decisions -- including putting too much money in their company's stock. Almost all of these issues pivot around one central theme: a lack of education, which is directly related to Deadly Sin No. 2.

Second Deadly Sin: Employers Don't Know What They're Doing

It stands to reason that many individuals have no idea how to make informed decisions regarding their investment plans, because the employers who oversee the plans often don't know what they're doing themselves. "Your 401(k) is usually organized by the personnel or treasury department -- by people who generally lack financial experience," said Gary Gensler, former undersecretary of the Treasury and co-author of The Great Mutual Fund Trap.

Ward Harris, founder of McHenry Consulting Group, a Berkeley, Calif., retirement-plan consultant, noted, "Most companies are busy making widgets and don't have the time or resources to educate themselves about retirement plans." Small and midsize firms, in particular, often find the burdens of educating personnel staffers in fiduciary responsibility unfeasible. So where do companies turn for help?

Enter consultants and asset management firms. Under this system, the company officials responsible for choosing the plans "get wined and dined by fund firms trying to sell them on letting them run their plans," Gensler said. What often ensues is that these outside firms provide the education and relieve the employer of the burden of paying for the administration of the plan. In exchange, the fund firm's offerings typically dominate the 401(k) plans.