The Seven Deadly Sins of 401(k) Plans

America, we have a problem.

With corporate pension plans going the way of the dinosaur and the Social Security system looking weaker every year, 401(k) plans have become the central component of most individuals' nest eggs. But these plans are peppered with flaws.

It's well known that Americans don't save enough, and voluntary 401(k) plans do little to rectify this chronic problem. But even good savers may not know that when companies set up savings plans, many rely on outside advisers that are beholden to mutual-fund companies. And these fund companies may charge lofty fees that are completely hidden from plan participants. A lack of education among employers adds to the problem.

"The 401(k) and retirement plan industry is on the brink of crisis," said Don Trone, president and founder of the Foundation for Fiduciary Studies, a nonprofit group that offers training for retirement plan sponsors and providers. "Baby boomers and generation X-ers are not going to be ready for retirement."

Defined-contribution plans such as 401(k)s -- which were originally designed to be only supplemental retirement plans -- are on the rise. In 1990, defined-benefit plans, or pension plans that companies funded, represented 69% of assets of employer-sponsored retirement plans, compared with 31% for defined-contribution plans such as 401(k)s. In 2002, defined-benefit plans were down to 58%, while 401(k)s and other defined-contribution plans were up to 42%. By 2012, 401(k)s and defined-contribution plans are expected to jump to 59%, with pension plans falling to 41%, according to research and consulting firm Greenwich Associates.

A Brief History of 401(k) Plans Click for our 401(k) timeline

"Increasingly, the 401(k) plan may be the first and only equity investment an individual ever makes," said William Wechsler, vice president of Greenwich Associates.

Indeed, more than two-thirds of Americans make their first equity investment through an employer-sponsored plan, according to the Investment Company Institute, a mutual-fund industry trade group. At the end of 2002, about 47 million Americans were participants in more than 432,000 401(k) accounts totaling $1.81 trillion in assets, according to the Employee Benefit Research Institute, or EBRI, a nonprofit retirement research organization.

To be sure, the growth in the investor class is a positive development. But Ted Siedle, a former Securities and Exchange Commission attorney who now runs Benchmark Companies, an organization that probes abuses in the asset management industry, noted a fundamental flaw: "Most 401(k) plans are terrible. The funds are lousy, the fees are sky-high, and the conflicts of interest hurt the individual."

So why are so many 401(k) plans awful, and how did they get so bad? A confluence of factors contributed to the problem, and the blame doesn't rest solely with the participant, the company, the outside consultants or the mutual funds -- although all play a part. Over the next few weeks, TheStreet.com will run a series of articles on the 401(k) quagmire, culminating with a Bill of Rights that readers can present to their employers. Today's introductory column examines the Seven Deadly Sins of 401(k) Plans.

Of course, not all 401(k) plans are a mess -- some companies' plans have that serendipitous combination of informed employers who offer comprehensive investing plans via cost-conscious consultants, and asset-management firms that balance their interests with those of their customers. Before reassuring yourself that yours is such a plan, read the following Seven Deadly Sins. How many turn up in your plan?