Four ways to change 401(k) plans for the better

Over the past few months, 401(k) plans have been in the news a lot. At one point, Republicans floated the idea of drastically lowering the maximum that employees could contribute. And this week, President Trump asked once again how everyones 401(k) plans are doing as a result of the rising stock market.

But what these plans need even more than a bull market is a way to get more people to participate in them, some experts suggest. Yes 401(k) account balances and stock market performance are tied to one another, but not everyone has access to these defined contribution plans, and few who do invest in them.

See: The stats that show why Trump vowed to keep 401(k) plans safe

Defined contribution accounts are a critical component to a persons retirement plan, said Jamie Cox, managing partner at Harris Financial Group, especially since the countrys retirement system is shifting from defined-benefit plans, also known as pensions, to employer-sponsored defined-contribution plans, like the 401(k) or 403(b). There is no other vehicle that exists that provides a platform for regular people to invest and accumulate wealth any faster, he said.

These 401(k) plans have become the dominant employer-sponsored plan type in the private sector, according to the U.S. Government Accountability Office. There were more than 103,000 defined-benefit plans in 1975, compared with about 45,600 in 2015. Meanwhile, there were more than 648,000 defined-contribution plans in 2015, up from about 208,000 in 1975. Still, Americans are not saving nearly as much as they should, even with an $18,000 pre-tax contribution limit to 401(k) plans (for those under age 50) and other vehicles, such as individual retirement accounts, to save for retirement.

Thankfully, 401(k) plans are no longer at risk for any contribution limit cuts; at one point it was rumored that annual limits would be slashed from $18,000 to $2,400. Theres also been a debate as to whether plans should be Rothified, which would shift when retirement savers are taxed on their assets. Traditional 401(k) plans defer taxes until the money is withdrawn, whereas Roth accounts use after-tax dollars to invest in the retirement account and investors pay no tax when the withdraw the money. But here are four suggestions for improving the 401(k) plan, according to retirement experts.

Expand contribution limits

Every year, the Internal Revenue Service reviews expanding contribution limits to these plans. This year, the maximum pre-tax contributions an employee can make to a 401(k) plan is $18,000, and next year will be $18,500. (Some plans allow for additional after-tax dollars to be contributed as well). But it would be nice for employees if these contributions were even higher, said Rose Swanger, a financial adviser at Advise Financial in Knoxville, Tenn. Only about 10% of Vanguard participants maxed out their 401(k) contributions in 2016, according to an analysis by the Center for Retirement Research at Boston College, down from 12% in 2013, but the option could be encouraging for people who do not understand the scope of how much they need for their retirements. Along with expanding contribution limits to 401(k) plans, even raising the contribution limits for IRAs (which are currently $5,500, with $1,000 catch-up limit) could help those without access to a plan, or who have maxed out their 401(k) plans, said Erika Safran, a financial adviser at Safran Wealth Advisors in New York City. Of course, raising the limit on pre-tax contributions would not be a short-term tax benefit, as it would decrease the amount paid in taxes in the present, but it would help in the long-term, when there is more taxable income to withdraw, she added.

Offer retirement plans to everyone

Not everyone has a 401(k) plan, either because they dont have access to one at work, or they arent participating in it (more than 55 million Americans do not have access to such a plan). States are beginning to tackle this issue by creating auto-individual retirement accounts for people without access to a workplace savings program. The problem is that, because these would be state-run plans, they would not be easily movable if someone were to leave the state, and therefore create numerous accounts with small balances, said James Choi, a finance professor at Yale School of Management. The government should consider offering tax credits for 401(k) contributions as well, which would potentially promote more savings, Cox added.

Also see: Heres what happens when you take out a loan on your 401(k)

Teach financial literacy

Even when Americans save for retirement, they may not be ready for it. Almost three-quarters of more than 1,200 retirement-age people who took a retirement literacy quiz offered by the American College of Financial Services failed it, with questions such as repaying loans on a reverse mortgage and when is the best time to claim Social Security benefits. People need to understand the best strategies for saving for retirement, as well as what is in their accounts, and that comes down to better financial education around these plans, said Paul Tramontozzi, a financial adviser at KBK Wealth in New York. It might even incentivize some employees to contribute more to their plans, he said. It has to be initiated by the employer, Tramontozzi said. Its important to educate employees on the long-term benefits of saving for retirement.

Give the choice of traditional 401(k) plans and Roth 401(k) plans

The Rothification of a 401(k) plan isnt necessarily a bad thing, but instead of making it either or, policy makers should consider offering both traditional and Roth plans to employees, said Byrke Sestok, a financial adviser at Rightirement Wealth Partners in White Plains, N.Y. If you are financially knowledgeable, youll appreciate having the choice between traditional and Roth 401(k) or 403(b) contributions, and youre also more likely to make the retirement savings contribution you need, he said. Traditional plans have tax incentives, which can encourage people to save more money in these plans and keep those assets in the plans longer (so as to avoid taxes on withdrawal), while Roth plans, without any knowledge on them, may incentive people to withdraw more than they need because there are no tax burdens upon withdrawal, he said. Still, there are times when the choice between either plan could be better suited for the retiree.

This story was updated on Dec. 19, 2017.

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