The unexplored frontier for 401(k) plans is whether partic­ipant account balances are going to be large enough to pay adequate levels of retirement income. It is, in the final analysis, the critical question.

Unfortunately, today's answer seems to be that 401(k) plans are not working well as retirement plans. That is, most eligible employees are not accumulating balances that, when coupled with Social Security, will provide the needed amounts of income at retirement. That is primarily because almost a third of the eligible employees are not participating in their plans and because, for most participating employees, the combined amounts of employee deferrals and employer contributions are not enough.

In a study by the Vanguard Group, "A Report on Vanguard Defined Contribution Plans 2004: How America Saves," an example is given of a 30-year-old participant who plans to retire at 65. The assumptions are that the participant’s compensation is $50,000, that the investment earnings are reasonably good, and that an income replacement ratio of 75% of final earnings is adequate. (The 75% income replacement ratio consists of Social Security and the anticipated income from the participant’s projected 401(k) balance at age 65.) In order to accumulate a large enough account balance to fund the needed income, the combined employee-employer contribution would need to be 17% of pay per year.

Unfortunately, the annual contributions to most partic­ipants’ accounts are much less than that—perhaps half.

In another study, the Fidelity Research Institute calculated the sustainable withdrawal rates for couples who retired at different ages. It posed the fundamental question: How much could a retired couple withdraw each year from their retirement accounts to have a 90% confidence level that the money would last for their lifetimes or, alternatively, to have a 50% confidence level? In other words, what withdrawal rates were sustainable for the life expectancies of both the husband and the wife?

For a couple retiring at age 60, in order to have a 90% confidence level that the money will last for their combined life expec­tancies, only 3.93% could be withdrawn each year. (By the way, these calculations contemplate that each year the amount of the withdrawals would increase by a 2.47% assumed inflation rate.) In order to have a 50% confidence level, the couple could withdraw 5.58% per year. Keep in mind that, if a couple withdraws at the rate with the 50% confidence level, there is about a 50/50 chance that they will run out of money before they both die.

On the other hand, if the couple retires at age 70 (with a 23-year combined life expectancy), a 4.47% withdrawal rate is sustainable at a 90% confidence level, while the 50% confidence level withdrawal rate is 6.21%.

Finally, the numbers for retirement at age 75 are for a combined life expectancy of 18 years, with a 90% confidence level at 5.5% and a 50% level at 7.38%.

What does this mean to plan sponsors and fiduciaries? In a nutshell, fiduciaries need to be paying more attention to these issues and need to be working with their advisers and providers to offer appropriate information, education, and services to participants.

In the 1990s, the emphasis of 401(k) plans was on the ability of the participant to save money, in a tax-deductible way, and to invest that money in mutual funds. However, we are beginning to expect 401(k) plans to be retirement plans rather than savings plans. Most people would agree that the definition of a retirement plan is one that provides reasonably adequate retirement benefits to participants.

Fiduciaries need to adapt and modify the operation of the plans to better achieve that objective. After all, fiduciaries are expected to act prudently under the "prevailing circumstances."

The first step is to educate participants about the concept of an income replacement ratio, the definition of adequate ­retirement income, the withdrawal rates that are sustainable, and so on. While this may seem like an increased burden for plan sponsors and fiduciaries, it should not be—or, if it is, that additional burden should be slight. That is because the responsibility of fiduciaries is to turn to their advisers and providers and to ask them to develop and implement solutions.