5 Ways Other Countries Do 401(k)s Better

Posted: Dec 23 2013, 7:06am CST | by


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5 Ways Other Countries Do 401(k)s Better
Photo Credit: Forbes

If you were to design a retirement program from scratch, you probably wouldn’t create what we have now.

The problems with the 401(k), IRA, Social Security “system” — or hodgepodge, if you prefer — are almost too numerous to count. The result of its flaws is that many Americans are on track to only replace half of their income in retirement, according to a Pew study earlier this year.

One of the reasons for this impending disaster is a monumental shift that occurred in our country in 1978: Companies began offering 401(k) plans instead of pensions. This transition from a retirement plan in which the payout was predictable (“defined benefit”) to one in which it wasn’t (“defined contribution”) left individuals to shoulder a lot of the risk and responsibility for their own retirement.

The first challenge defined contribution plans such as the 401(k) present is getting workers to save enough. But even if workers manage that feat, upon retirement, they’re faced with yet another tricky question: what to do with their nest egg. If you have heard about how poorly lottery winners manage the huge sums of money they receive, you could hazard a guess that retirees aren’t much better when their 401(k) plan writes them a check for, say, a half million dollars, on their retirement day — which is typically called the “lump sum” payout.

For this reason, among many others, the U.S. Government Accountability Office conducted a study, released last week, of how other countries who offer similar defined contribution plans manage their programs.

“401(k)s first came in in 1978,” says Charlie Jeszeck, the GAO’s director of education, workforce, income security team. “So now you start having people who first approaching retirement, and they are the first graduates of the 401(k) system, and a key aspect of that — now you’ve accumulated an account balance, what do you so with it? So this report focuses on the decumulation or the spend-down phase and different strategies. How should people draw upon their retirement resources?”

The study did not look at countries with pension systems such as France, Italy or Scandinavian nations, but instead six select countries with defined contribution plans — Australia, Canada, Chile, Singapore, Switzerland and the United Kingdom. Here are some of their ideas which could help us improve the 401(k).

1. Multiple Options In Addition To The Lump Sum

There’s no doubt the lump sum option can be overwhelming to people: In broad strokes, it requires people to hazard a guess as to how long they will live, how their expenses will change in retirement, how inflation will affect those costs, and how they should invest as well as withdraw their assets in order to meet those expenses. On the other hand, the upside of the lump sum is that it gives people flexibility and access to their savings if they need it immediately, and allows them to invest as they want. (Learn how to avoid these five investing mistakes.)

But two options other than the lump sum could be right for other retirees:

  1. Programmed Withdrawals: a series of fixed or variable payments from the retiree’s account that tries to produce a relatively stable annual income and allows him or her to keep invested in the market, though the savings and payouts are not guaranteed to last for the retiree’s lifetime.
  2. Annuities: guaranteed payments made through an insurance company for a set period or the retiree’s lifetime, though the money used to purchase the annuity cannot be left as an inheritance.

While most 401(k) plans only offer the lump sum option, the six other countries in the study have moved to offering multiple choices.

“In the U.S., you can get at these other options, but they’re not intertwined with the whole retirement system,” says Jeszeck. “You can get an annuity, but you’ll buy it on the retail market and you won’t get as good rates as if you bought it in a group setting. You could give your money to a financial advisor or one of these investment companies and they could set up a structured drawdown for you, but you have to face the retail market on your own without the support and information that governments and regulators provide participants in these other nations.”

See the GAO’s model of various hypothetical retirement scenarios, such as how programmed withdrawals compare to annuities and more.

2. Improved Communication With Plan Participants

Other countries also put a priority on disseminating information to account holders. “In Australia, they provide this booklet developed by the government — and it shows, for each option, here are the drawbacks and here are the benefits…. They’re making sure the participant has the right information,” says Jeszeck.

Similarly, four to six months before someone’s retirement, the UK sends him or her a “‘wake up pack,’ which informs people of their rights to shop around so they’re not staying with the same provider, instead of playing into inertia that people just stick and not move,” says Jeszeck. Additionally, Chile and the UK require plans to provide participants monthly or yearly projections of their retirement income be in their benefit statements.

Currently, 401(k) plan benefit statements only show the account balance, and an April 2013 study by the Department of Labor found that more than half of plan statements do not include projections of the participant’s balance at retirement or the income they could expect in retirement.

3. Boosting Requirements For Financial Advisors
Three countries strengthened safeguards for financial advisors so that participants can receive objective recommendations from professionals. For instance, the UK protects its participants against advisors who charge inappropriate fees and prohibits advisors from receiving commissions on products they sell. (Read about a new type of American retirement income financial planner here.)

4. Mitigating The Risks Of Lump Sum Payments

Several countries took measures to reduce the risk of outliving one’s nest egg by taking the lump sum. For instance, participants in three countries had to meet retirement income requirements to withdraw their assets as a lump sum. Four of the countries regulate the programmed withdrawals to keep participants from spending their savings too quickly, with the calculation taking into account the participant’s life expectancy and projected investment return. (This study showed the best way for retirees to invest so their nest egg lasts.)

5. Centralizing Annuity Options

“There’s, to varying degrees, some effort to centralize where you can purchase annuities to make it easier. Chile set up all three options from the get-go under certain conditions and restrictions, and they’ve made efforts to see all the competing annuity quotes in one place to help people purchase the best option,” says Jeszeck. Chile is also doing studies to see the impact of telling people how their balance will grow over time.

While many of these features would improve the U.S. system, it remains to be seen which will be adopted.

“Basically, we want to move away from the idea that when you retire now, people say, ‘Here’s the money, there’s the door,’ to the plan sponsor saying, ‘Here are some options to consider, how to make your money last throughout retirement. Here’s what a strategic spend-down looks like. Here’s what annuities do. Here are places where you might get good prices for annuities,’” says Jeszeck. “That’s where these other countries have been moving to, and that’s where — with the conclusions and findings of this report — we would like to see the U.S. go.”


10 Questions To Ask A Financial Advisor

Photo: 401(k) 2013/Flickr

Source: Forbes

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