Making 401K Plans Work Better

401k plans are better than traditional pensions. They are also way better than Social Security, assuming they are used correctly.  The issue is that they are often poorly invested.  Some people are too scared of losing money, so they leave everything in the money market their entire careers. They then miss out of the growth they could have had if they had invested. Many don’t think about retirement through their twenties and thirties. As a result they don’t enter the 401k plan until they are in their forties or fifties. Others don’t contribute enough to the plan to fund a confortable retirement. Still others are too aggressive when they are nearing retirement, usually because they are trying to make up time, and see a market crash wipe out half of their portfolio value right when they were ready to head out-the-door.  Still others borrow against their 401k plan, or take the money out entirely, when they have a big expense like a wedding or change careers and need some seed capital. They then liquidate the account right when they were about to see the big gains created by compound growth.

These issues could be easily solved.  The reason they occur is the rules behind 401k plans that allow or even encourage behaviors that are destructive to the employee’s retirement.  People have no choice in the amount they contribute to Social Security or pension plans.  The employer or the government dictates how much of the employee’s pay is contributed and how much they provide.  And at least with Social Security, you have no choice but to participate.  You are enrolled whether you like it or not.  Employees can choose not to enter the pension plan at some companies, but most realize that they should and they do enroll.  Likewise, you can’t borrow against your pension plan or Social Security or take it out early.  In the case of pension plans, they are invested in a mix of stocks and income investments in a manner that is appropriate for the goals of the plan and the payouts that must be made.

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The sad part is, if people were to put all of the money they are putting into Social Security (about 13% of their paycheck) into a 401k plan and invested it properly, everyone who worked their whole life would be set for retirement.  There would be no issue paying for living expenses and medical bills.  The senior discount would vanish since most seniors would be multi-millionaires.  Unfortunately, people don’t think about their futures and plan.  They either see the big pile of cash they’ll need to build up to have  comfortable retirement as being either too difficult to achieve or retirement too far out in the future, so they sabotage themselves.  Much as I hate to see central government planing and control, some regulation is needed to nudge people in the right direction.  Unlike Social Security, where the government has proven that they’ll just squander any money given to them, however, government involvement should only extend to preventing people from drawing the money out to soon, not enrolling at all or not contributing enough,  or investing the money in a way that is too timid early or too aggressive late.  Here are some regulations that would make 401k plans the path to comfortable retirement for all:

1.  Required enrollment.

Employees should be required to contribute at least 5% of their pay to a 401k plan to ensure they’re putting enough away for at least a basic retirement.  While I hate to force people to do anything, it is for the good of society to not have a group of destitute retirees.  As an incentive to contribute more, the rules could eliminate the need to make a Social Security contribution if at least 10% of an employee’s paycheck is being contributed to a 401k, between the employee’s contribution and the employer’s.

2.  Forbid withdrawals until age 62, then limit withdrawals until age 70.

There is no good reason for people to be pulling their retirement savings out early, and again, doing so subjects society to the burden of carrying a lot of destitute old people.  No withdrawals should be allowed until the employee has reached at least the age of 62 (which also encourages people to work longer and reduce the number of years they’ll need to be supporting themselves with their savings).  To prevent people from pulling all of the money out at age 62 and blowing it, they should only be able to pull out a portion, like 5%, each year until they are age 70.  Hopefully by that point they will have learned that it is a good thing to take the money out slowly since then the account has the ability to recover and generate more money and they’ll continue that behavior from then into old age.

3.  Eliminate borrowing of funds.

Just as funds should not be withdrawn, they should not be borrowed.  If people want to pay down credit cards, start a business, or upgrade their home, they should find the money elsewhere and not from their retirement savings.  People shouldn’t live beyond their means at the expense of their retirement funds.

4.  Remove the money market option for those under age 58.

There is zero reason for anyone to have a dime in a money market fund within a 401k account until they are getting close to using the money.  Removing this option would force employees to invest the money, which would allow the money to grow and prevent inflation from reducing their spending power in retirement. After being invested for a few years and seeing a bear market or two, they’ll learn that things recover if they just stay the course. They’ll also see the huge returns they get by being invested during the bull markets.

5.  Require a professional money management option.

Most people know little about investing.  An option where a professional money manager just invests the money for employees should be included.  This would be similar to a traditional pension plan, except the money manager could invest for groups of employees separated into different age brackets instead of investing everything as one big account.  Because there would just be a few, large accounts (maybe three), instead of a lot of little accounts to manage, and because the manager would be investing in mutual funds instead of individual stocks, the cost would not be very much.

6.  Limit the contribution of company stock by employers.

Some employers like to issue company stock as their contribution instead of giving cash because cash is more precious.  This puts an employee in a risky position since he/she then has a big position in one company – their employer’s.  They could both lose a job and see their 401k decimated should the company misread market conditions.   A reasonable limit, such as 1% of salary, should be placed on the amount of company stock that can be issued by a company for a 401k contribution.  Alternatively, require a company match at least 5% of salary with cash before issuing stock so that the employee at least has 10% of his/her salary going into the 401k in a diversified manner before concentrating in company stock.  Employees should also be able to sell shares that a company distributes to them immediately and shift the money into mutual funds where it will be appropriately diversified if they wish.

7.  Require low-cost index fund options in each plan.

Research has shown that low-cost, passive funds will beat out high cost, actively managed funds over time.  Unfortunately, some employers only have high cost funds available.  Every 401k plan should at least have the choice of a large cap, small cap, international, and bond index fund in their investment mix.

8.  Auto-enroll employees in a target date retirement fund.

Even when they do enroll (usually through automated enrollment), many employees tend to wait to get into their 401k plans and make their investment choices, sometimes for years.  Currently, many 401k plans auto-enroll employees in a money market fund, meaning they are losing money to inflation until they shift the money somewhere better.  Instead, they should be auto-enrolled in a target date retirement fund so that at least they’ll have a reasonably good investment plan until they get the time and motivation to take a little more active role.

To ask a question, email or leave the question in a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing


  1. I’m curious what your thoughts are for the market this coming year. People keep saying the market is crashing or going to crash and my husband wants me to move a good chunk of my 401k temporarily to a money market fund to ride things out. I know it’s probably an involved answer but I’d love to know your basic thoughts.

    • This would actually make a great “Ask SmallIvy” article, so I think I’ll go ahead and create one with the full answer if that would be OK.

      Short answer is that I could see it go down or just draw lines and not go much of anywhere for a while. It has already gone down substantially, making me think it will probably not decline a lot more, but the Fed is raising rates to fight inflation which tends to have a chilling effect on the economy (the whole point of raising rates) which hurts earnings, and therefore stocks. We are likely to go into a deep recession as rates are raised and businesses contract. Is that already priced into stocks? Maybe. People also don’t have a lot of money to spend after inflation and will have less as their credit card rates go up (although I’ve seen that malls and restaurants are packed like Christmas right now). There has been a substantial amount of inflation, however, which has not been reflected in stock prices, so eventually they’ll need to go up in price even if they don’t actually go up in value since spending power has declined.

      The more important thing, however, is to realize regardless of what happens, stock prices are likely to regain any losses and continue on their way within a few years. Your decisions should therefore be driven by when you need the money and your personal tolerance for risk. Guesses about what the market will do should not matter. You should always be prepared for a 40% drop in portfolio value with a two to three year recovery period. If you absolutely need some money in a few years, it should be in cash/bank CDs. If you could take a 40% hit and still have a big enough portfolio to sell some shares at the reduced prices and muddle through while things recover (realizing you don’t need all of the money at once typically and retirement is a 30 -year process, not a 1-year process), you can leave money invested. You can also reduce volatility and risk by diversifying into bonds and fixed income, foreign stocks, real estate, etc…. You’ll still see a decline, but i9t moight be 10 or 20% instead fo 40%. The income generated also helps if you need cash flow to pay for things. It’s a great situation to have where all of your expenses are covered by dividends, interest, and rents where you really don’t care about the price of your stocks as long as dividends don’t get cut. The higher rates are starting to make dividend stocks and bonds look more attractive (higher interest rates will temporarily push bonds prices lower, however). Higher rents are pushing up real estate income.

      • Thank you, this is super helpful! God willing I can retire in 10 years, so I still have some time to re build. Not 30 years though.

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