What's the case against 401(k)s?

They're failing to provide enough money for older Americans. As the country's principal way to save for retirement, the 401(k) program allows employees to set aside a portion of their paychecks, often supplemented with matching funds from their employers, and to defer taxes until they start withdrawing funds. But most of the nearly 80 million baby boomers — the oldest of whom are just now starting to turn 65 — haven't put aside nearly enough, and are in danger of exhausting their savings within a few years of retirement. "It has already become clear," said Karen Friedman, of the Pension Rights Center in Washington, D.C., "that 401(k)s have failed millions of Americans."

How much have people put aside?

The average balance in all 50 million 401(k) accounts is just over $60,000, according to the Employee Benefit Research Institute. Even people within 10 years of retirement have saved an average of only $78,000, and more than a third of them have less than $25,000. More than half of U.S. workers have no retirement plan at all. With Social Security averaging $14,780 a year for individuals and $22,000 for couples, many Americans will exhaust their savings in just a few years. Since millions of boomers are likely to live into their 70s and 80s, the country is headed toward a major crisis. "It looks like most middle-class Americans will become poor or near-poor retirees," said Teresa Ghilarducci, a retirement specialist at the New School in New York.

Why are balances so low?

The financial crisis is partly to blame. It knocked $1.6 trillion, or about a third of the total value, off the nation's 401(k) accounts. But the larger truth is that most Americans do a poor job of anticipating the future and saving money. People don't seem to grasp that the pensions their parents' generation enjoyed have been almost entirely supplanted by 401(k)s, leaving them largely on their own to fund the final stage of their lives. In one recent survey, 43 percent of workers between the ages of 45 and 54 said they weren't currently saving for retirement at all. Very few 401(k) participants contribute the annual maximum of $17,000, and people tend to stop funding their retirement — or even borrow against balances — when they change jobs or have debts to pay. Most 401(k) account holders have little knowledge of how to manage stocks and bonds over decades to produce the best returns.

How did we come to depend so much on 401(k)s?

The Revenue Act of 1978 created 401(k)s — their name comes from the relevant subsection of the Internal Revenue Code — as a way for corporate executives to supplement their traditional pensions with extra cash. But when employers realized that they could use them to slash their pension costs by shifting the burden of retirement funding to employees, they adopted 401(k)s in droves. In 1980, 60 percent of private-sector workers with retirement plans had employer-paid pensions; by 2006, only 10 percent did, and 66 percent had 401(k)s. The chief selling points of 401(k)s are that they allow workers to take savings with them if they change jobs and to decide how — and how much — to invest in their retirement. But even automatic enrollment and free financial counseling haven't compelled people to save enough.

How much should people really be saving?

More. Far more. Many people are still assuming that they'll get 10 percent annual returns on their savings; the stock market volatility of recent years would suggest that's overly optimistic. To provide for a retirement lasting 20 years, Vanguard, a major 401(k) administrator, now recommends an annual contribution of 12 to 15 percent of income, including an employer's match. But even that is only enough if you start young: A worker who starts contributing at 35 and earns $43,000 has to sock away more than $10,000 a year, the Center for Retirement Research estimates, to maintain his or her lifestyle after retiring at 65. The Employee Benefit Research Institute says the average earner will need $900,000 upon retirement — a sum few people are on target to reach.

So how will boomers cope?

Many will just have to keep working. They'll also have to move into cheaper housing, cut back on travel, and live with far greater financial uncertainty. "The baby boomers will be the first generation that will do worse in retirement than their parents," said the New School's Ghilarducci. That's not news to Gloria Moss. Now over 60, she has been saving in a 401(k) since 1985, but has only half what she needs. "I am going to probably have to work considerably longer than I anticipated," she said. Financial adviser Paul Merritt says most of his retirement-age clients reach the same conclusion after taking a hard look at the numbers. "The discussion turns out to be: What kind of part-time work do you want to do after you retire?"

Skimming off the top

Future retirees don't have only themselves to blame for paltry retirement savings. Excessive management fees also play a role. Every day, Americans pay about $164 million in 401(k) fees to the financial industry. "There are enormous dollar amounts involved," said Frank Cirullo, a former plan consultant. "Employees are getting ripped off." Fees vary from plan to plan, and can run anywhere from 0.5 to 2 percent of assets per year. An extra 0.5 percent annual fee can cut an employee's savings by 10 percent by the time he's 65, according to Vanguard. Most 401(k) fees have long been hidden, but under new rules taking effect this summer, plan providers have to give detailed breakdowns of all the fees to employers, who in turn have to inform employees. Savers can only hope that transparency kicks off competition that will lower fees.