The Growing Problems With 401(k) Withdrawals

NEW YORK (TheStreet) -- Company 401(k) plans allow employees to save during their working years and then make withdrawals to provide retirement income.

In recent years, employees have become more adept at saving. But now many employers are concerned that retirees are botching the job of making sensible withdrawals.

Frightened about market uncertainty, some retirees are reluctant to take any withdrawals at all. Other plan participants are raiding their savings, quickly depleting the assets.

A decade ago, the withdrawal problems were not big concerns because there was not much money at stake.

Typical employees had less than $10,000 in their 401(k) accounts. But now the 70 million baby boomers are retiring, and many have been putting money into their accounts for two decades.

Half of 65-year-old participants have more than $80,000 in their 401(k)s. That is enough cash to have an impact on the lives of retirees.

To address the problems, some employers are hiring outside advisory firms to counsel plan participants.

Advisers urge retirees to obtain reliable income by staying diversified and taking systematic withdrawals.

In a typical approach, an adviser urges clients to withdraw about 4% of assets in the first year. After that, retirees can increase payments by 3% annually to provide protection against inflation.

The counseling efforts are still in their early stages. Among the first companies to roll out a service is Vanguard Group. Participants who select the service can receive advice over the phone. Retirees can use the Vanguard Web site to buy annuities or make other investment choices that will provide steady income.

Among the most ambitious services is offered by Financial Engines (FNGN), an advisory firm. Founded by Nobel Prize-winning economist Bill Sharpe, the company has long provided advice to 401(k) participants on how to accumulate assets.

Last year Financial Engines expanded its services to include special guidance for how to take retirement income. To obtain the full range of services, 401(k) participants pay fees that range from 0.2% of assets up to 0.6%.

Financial Engines currently provides advice to 589,000 participants. So far only a few have started receiving advice on withdrawals.

Those who elect to join the program can talk to an adviser over the phone about how to manage portfolios and take withdrawals. The advice can be customized.

But Financial Engines has developed a model for typical retirees who want to generate steady income. The strategy is extremely conservative. Although some competitors suggest that retirees keep 50% of assets in bonds, the Financial Engines approach calls for putting 80% of the assets in fixed income and the rest in stocks.

"The model is designed to provide a steady stream of payouts -- even if the markets go down," says Christopher Jones, chief investment officer of Financial Engines.

In the model, the retiree starts by putting 20% of assets in stock funds and 65% in short and intermediate bond funds. The rest of the assets go into a conservatively managed reserve fund.

The retiree starts taking withdrawals from the bond funds. Those should provide enough income to cover fixed payments for 20 years or so.

If the stocks rise, then they can be sold and used to provide retirees with annual increases in income that can protect against inflation. But if stock markets stagnate or fall in coming years, then the retiree will only receive fixed payments and no inflation protection.

Financial Engines figures that during the bull markets of the 1990s, retirees could have sold stocks and increased their payments by an annual rate of 6.5%.

But during the difficult times of the past decade, retirees could only get annual raises of 1%.

The assets in the reserve fund can be used to purchase an annuity that will provide guaranteed income for life. Some 65-year-olds may elect to buy an annuity right away. Others may decide to take an annuity later or not at all.

In a typical annuity, a retiree could pay $300,000 to an insurance company and receive lifetime monthly payments of $2,400.

Most retirees are reluctant to buy annuities because they are complicated and cumbersome to use. But they can be sound investments, and the Financial Engines advisers are willing to explain the details to clients.

Retirees who decide not to buy an annuity can hold the reserve fund for emergencies. That way plan participants can pay unexpected bills and not disrupt their regular income streams.

Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.