It's time to fix the 401(k)

The 401(k) plan can be a powerful savings tool. But for more of us to enjoy a secure retirement, we need a bigger, better idea.

Alicia Munnell is a Harvard-trained economist. She served as an assistant secretary of the Treasury and is regarded as one of America's foremost experts on 401(k)s. You'd think she'd be terrific at managing her own retirement, but even she has to fess up to some mistakes. "When my son got married, I took some money out of my plan to help," says Munnell, who heads Boston College's Center for Retirement Research (CRR). "And I ended up paying a 10% penalty and taxes."

In the jargon of the retirement business, that's called leakage. It's a common problem: About 60% of job switchers with a 401(k) plan cash it out.

That's just one of the many pitfalls. Lots of people start saving too late, save too little or make missteps with their portfolio. And all of us are vulnerable to risks that we can't control. Your employer might not offer a plan or might choose one with second-rate investments. Or you may hit a market storm at precisely the wrong moment: the year you stop working.

That last problem is especially obvious now. Over the past 12 months, a 64-year-old investor in an age-tailored "target date" mutual fund has lost 26%. Savers with high balances can recover from that. But many lost more, and the typical near-retiree with a 401(k) has less than $50,000 stashed away in it. That will spend down quickly, and once the money's gone, it doesn't matter if the market roars back.

A recent CRR study shows that a bear market retiree could easily end up with just half the income from a 401(k) as someone retiring during a bull market. "Any system that delivers such wild swings in retirement income is just not working," says Munnell.

She isn't the only one who's worried. A growing number of policy experts who study 401(k)s think they fall short. So why not rethink America's retirement system from the ground up? No, it won't be easy: We're in an economic crisis, and lobbyists for the financial services industry will fight like tigers for the status quo. But that doesn't make the task any less urgent. Some 78 million baby boomers are hurtling toward retirement. Their poverty, if it comes to that, will be a burden to their children and lead to calls for taxpayers to support them.

What would a better system look like? It would be universal and strike a more conservative balance of risk and return. Most of all, it would be designed for savers, not employers or money managers. Here are five principles for reform.

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It's time to fix the 401(k)