By Jeremy Vohwinkle 16 Comments

The 401k gets a bad reputation, especially when the markets and economy are on the rocks. We read countless stories about 60-somethings on the cusp of retirement who lost half their nest egg and need to continue working, they had followed every step for how to become a millionaire but never made it. We hear about how people arent putting enough money into the plans to be able to afford the retirement they planned on and how we should be giving a maximum 401k contribution. These are all real problems, but is it the 401k’s fault? I don’t believe so.

First, we need a quick refresher on what a 401k plan is because most people know very little about them other than the fact that their employer may offer one. To be specific, a 401k is simply a type of account provided by individual employers to accept salary deferrals from employees while taking advantage of the tax benefits outlined in the tax code. In fact, the reason it’s called a 401k is because of the part of the tax code where the plans are outlined.

The 401k isn’t a government plan, there are no requirements for employers to provide them. and there is not a single company or administrator that handles all plans. It is simply an optional benefit that many employers provide which allows employees to set part of their income aside, before tax and tax-deferred, for retirement. Aside from the specific instructions within the tax code and throughout some regulations in the financial industry, every plan is a little different. Unfortunately, this means not all plans are necessarily created equal.

The Perceived Risk of 401ks

Everybody loves to point to stories about workers who were just a few short years from retirement in 2008 only to soon find half their nest egg wiped out. These are true stories. I know because it was during this time I was still working as a retirement plan consultant and I was helping employees manage their 401k/403b plans. I saw it happen right before my eyes. But what’s really at fault here?

Even though the 401k has come into existence thanks to the government and its tax code, they are still largely individual plans when it comes to how you participate. As the employee, you are responsible for determining how much to contribute and selecting how your money is invested, at least from the options provided by your plan. According to recent data, the average 401k offered 24 investment options. While there are some plans that offer only a handful of choices, the thing to keep in mind here is that your employer isn’t holding a gun to your head and saying you must put your entire retirement nest egg into a large-cap stock fund and to just pray for the best. You have options between stock funds, bond funds, and often many other investment choices.

While a small company 401k may not have the best, most, or cheapest investment options out there, there’s absolutely no excuse for hearing stories about how the 401k is too risky because 65 year olds were invested nearly 100 percent in stocks and now have to put off retirement because the stock market took a dive. The 401k didn’t tell that person to invest their money that way. And you certainly won’t find that advice coming from a professional, or even anywhere else for that matter. As unfortunate as situations like these are, it’s all too easy to make the plan itself the scapegoat rather than question why the investor felt the need to risk their money in such a way.

This isn’t to say the 401k is without faults, because that is clearly not true. We’ve got a long way to go before leveling the playing field. The nature of how these plans are set up inherently means some plans will be better than others. But if you have a 60 year old invested in Plan A, which only has six investment choices and 1.5% annual expenses, and a 60 year old invested in Plan B, which has 30 investment choices and 0.5% annual expenses, if both of these investors wanted to retire early at 62 and were betting heavily on stocks when the market suddenly drops 30 percent they are both screwed equally. It wasn’t the fees that put their retirement on hold (although over the long run they certainly don’t help) and it wasn’t the lack of investment choices. Ultimately it comes down to how they invested their money. You can blame the 401k all you want for their misfortune, but if the same person had all of their money in a Vanguard IRA invested in an inexpensive stock index fund they would be in pretty much the same boat.

The Real Risk of 401ks

The nature of the 401k itself isn’t responsible for putting someone’s retirement in jeopardy. Instead, there are two big risks that fall on the shoulders of the individual. The first is simply not saving enough for retirement. Ask almost anyone if they are maxing out their annual contributions and you’ll find that they aren’t. In fact, most people struggle to set aside just $5,000 a year, which is less than a third of what’s typically allowed. While saving a few thousand a year will go a long way toward building a retirement nest egg, it will almost certainly not be enough to fully fund the retirement of your dreams.

The second big risk comes from making poor investment decisions. Even if you are able to put aside a large sum every year into the plan, if you don’t know how to manage this money you could find yourself in the headlines when you’re a year or two away from retirement and you’ve just lost most of it because you were not invested appropriately.

The only way a 401k plan works is if you start saving early and if you save enough that you can reach a realistic sum of money upon retirement. In addition to saving enough you then have to be smart with the money and invest it appropriately for your risk tolerance, time frame, and the stage of life you’re in. If you’re able to save enough and put the money to work in a suitable manner, you’ll almost certainly bid your working life farewell with a comfortable nest egg that will allow you to coast through retirement. But if you spend thirty years just putting 100 bucks a money into the account and let it all ride on stocks (or similarly park it in the fixed account that doesn’t even earn one percent interest) you’ll have a pretty dismal retirement party, if you’re ever able to retire at all, you cant retire broke .

Again, this failure has nothing to do with the 401k itself. Even if you didn’t use a 401k and you put 100 bucks a month into an IRA or another investment account and then invested the money foolishly, you’d end up with the same outcome. Also if you put the money into a 401k and then start taking out 401k loans to fund other things in life it is not the 401ks fault.

There’s No Free Lunch

As pension plans fade away we’re left with the burden of saving for our own retirement. Unfortunately, some people feel that it should be up to the government to provide this benefit, either through Social Security or some new program. That’s not going to happen. For one, Social Security was never intended to be a retirement plan. It was created in the 1930s as a safety net that provided something in old age. And you must remember that back when Social Security came into existence, the average life expectancy was only about 62 years. Today it’s nearly 80. As you can see, the program was never designed to provide a few decades worth of comfortable retirement income, and it never will be. When you finally ignore Social Security, even though you’ll probably get some sort of benefit from it or whatever the program evolves into, you must recognize that the only person who can ensure you have a comfortable retirement is yourself.

It doesn’t matter if you contribute to a 401k, a Traditional IRA, Roth IRA, buy real estate, or keep money in savings bonds or in CDs at the bank, the bottom line is you need to be responsible for setting aside the money for later. The government isn’t going to do it for you and unless you’re fortunate enough to work for a company that provides a pension benefit, nobody else is going to either.

What You Can Do to Ensure Retirement

Since the ball is in your court, it’s up to you to put a plan in place to ensure you’ll be able to retire on your own terms. You can complain about the government wasting money or about Social Security going bankrupt, but that won’t solve your retirement problems. So your best bet is to put your head down and get to work, after all wouldnt it be best to be saving too much for your retirement ?

First, it’s important to recognize that something is always better than nothing. It’s easy to feel defeated when you realize you can’t max out your contributions or save what it will take to reach your magic number. So if you can only afford to save $50 from every paycheck, that’s fine. Just be sure to actually put that $50 toward retirement instead of feeling bad about how it’s less than you need to save. Again, doing something in this case will always be better than doing nothing. The best part is that you can always increase this amount later. Over time you may have more cash flow and can contribute more, or maybe you end up streamlining your budget which allows for larger contributions. Either way, do what you can now and work on increasing that as time goes on.

Next, make sure you’re investing the funds appropriately. Especially when you’re younger, you may feel like swinging for the fences by taking on a lot of risk with stock funds. While that can work out since you have time on your side, it’s still a good idea to create a solid diversified portfolio that’s suitable for your age and your ability to stomach market swings. Slow and steady often wins the race, especially if it means you aren’t constantly getting spooked out of the market whenever things turn south for a while. And of course, stay on top of your investments and adjust your holdings as you age, there may come times that is it wise for you to link into rolling over your 401k into other accounts, especially once you have left an employer. Don’t become media fodder when you’re 65 and now find yourself needing to work the rest of your life because you were still invested in all risky stock funds just months before your retirement date.

Finally, examine your 401k carefully. As mentioned earlier, not all plans are created equally and there are some plans out there that downright stink when you look at the fees and investment choices. So if you find that you can’t invest in anything with less than a 2 percent annual fee, it’s fine to turn your attention to other options. If you’re still eligible to contribute to a Traditional IRA and deduct the contributions you can always go that route. Or maybe you’ll open a Roth IRA. Or maybe you have a side business and can open up a self-employed retirement plan. Either way, if your 401k plan is truly bad it might be a good idea to look at alternatives.

So, is the 401k too risky for retirement like the media often says? Not at all. The real risk is that since we’re all largely responsible for our own retirement, the fact of the matter is most of us aren’t saving nearly enough, or when we do save we’re making poor decisions with the money. These mistakes are made regardless of the investment vehicle used. I can understand the arguments people often make when pointing out that 401ks dont work because even those who do utilize them often come up short, but this would be true for any investment vehicle thats 100 percent optional. Just imagine how many people wouldnt contribute to Social Security if it was optional, yet demand benefits when they need them later. Until theres a way to force people to save Im afraid its up to us to make good decisions with our money and stop thinking somebody else is going to step in and take care of it for us.

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My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.