Over the last few decades, there has been a fundamental shift in Americans' options for retirement plans. We are increasingly forced to take responsibility for our non-Social Security retirement investments, and yet evidence shows most of us don't know how. One-third of Americans reach retirement age with only Social Security to fund it. For low-income people, that number is 75%. The result is that the majority of Americans cannot afford to retire.

Labor economist Teresa Ghilarducci describes 401(k)s and related plans as a failed experiment. Fortunately, there are some things you can do individually to improve your own situation.

What has changed?
When it came to retirement, it used to be that many Americans were heavily reliant -- apart from Social Security, which we address in another article -- on an employer-sponsored pension or similar vehicle. These "defined-benefit plans" promised a predetermined monthly benefit for the retiree based on factors such as the employee's age, salary, and length of tenure.

Since 1980, the landscape has shifted heavily in favor of defined-contribution plans such as 401(k)s and 403(b)s. Within these plans, employers usually pay a fixed amount into an employee-directed investment account. The fundamental difference is in the nature of the promise: With many defined-benefit plans, the guarantee is in the pay-out; with defined-contribution plans, the guarantee is in the pay-in.

Simple factors for a fabulous retirement
Let's look at the factors for success in 401(k) management.

Know your number. Your planning should begin with a fundamental question: How much money do I need to retire? The general rule is that you need about 20 times your annual salary. With an average salary of $56,715 a year, a teacher in Ohio would need to save $1,134,300 in order to retire without compromising her standard of living. This is in addition to what she would get from Social Security. Now consider that "60 percent of workers report that the total value of their household's savings and investments, excluding the value of their primary home and any defined benefit plans, is less than $25,000," according to the Employee Benefit Research Institute. That is a devastating shortfall.

Accurately determine when you will die. I'm shuddering just thinking about this. If you die before you predicted, no harm, no foul. If you live longer, then your blessing of longevity could come with a curse of abject poverty. Did you catch that? You could be a year or two away from death and literally be penniless. What are you going to do then? Go get a job at the Quick-E-Mart? I'm being sarcastic, but a lot of people believe just that. What a way to spend your golden years. Then there is the unpredictable prospect of illness, either your own or your spouse's. So are you the betting type?

Competently manage your investment account. Well, folks, here's where the rubber meets the road. When you have a 401(k), when and how you invest your money is entirely up to you. That's part of the attraction, of course. You just need to be the kind of private investor who makes consistently smart decisions, such that your account grows into the cushion you need it to be. Simple, right?

So how are we doing?

Reality check
You should probably sit down for this part.

  • Only about half of American workers have access to a 401(k) plan, and only about 30% of American workers actually take advantage of that plan.
  • According to the UC Berkeley Center for Labor Research and Education, about 75% of 401(k) account holders have balances below the frequently cited average of $60,000. The median account balance is less than $20,000.
  • More than a third of U.S. households end up at retirement with only Social Security.

Now why would this be? Why do those 401(k) plans look so dismal, when they were so heralded? It turns out that most people are terrible investors, and worse still, few are even interested in learning to do better.

The Dodd-Frank Wall Street Reform and Consumer Protection Act required the SEC to study financial literacy among retail investors. The SEC published the results of that study this August. It makes for dire reading. Consider the key finding: "Investors have a weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid investment fraud."

To put this more clearly, most investors do not understand such fundamental notions as compound interest and inflation. Notice that we're talking here about investors, not the general public. These folks are already market participants, and they don't have even the most basic comprehension of the abyss into which they're tossing their cash.

But what about other assets, you ask? People have home equity, don't they? Well, the bursting of the housing bubble fundamentally compromised the security we once derived from home-ownership. A Sept. 16, 2012, New York Times editorial revealed that the housing collapse had "erased nearly $6 trillion in equity, and left nearly 13 million people owing a total of $660 billion more on their mortgages than their homes are worth, according to Moody's Analytics." I almost can't get my head around that, but I know it's ugly.

Right, so relying on your home equity is out. "But I'll just work longer," you protest. Really? This falls into the realm of magical thinking. It's all well and good if it works out, but think it through. If you're in a labor-intensive job, how long are you willing to bet on your body's resilience? What happens if you have an accident, or fall ill? What will you do if a 22-year-old gets hired to do your job for half your salary? Again, maybe you're the betting type, but I don't like those odds.

The road forward
Now that I've left you wallowing in misery, let me shine a ray of hope onto your forlorn countenance. All is not lost. We'll take a look at the macro level first, and then we'll zoom in to you.

I recently interviewed Jean Setzfand, AARP's vice president for financial security. She said most people are trying their very best, but the system is set up for failure. As a result, Setzfand said, "people end up taking the ostrich approach of getting to it later." She thinks the blame shouldn't fall exclusively on individuals.

Part of the solution could be a policy one. We could consider the system failed and seek to change it. This is precisely what many influential people promote, including Ghilarducci, the labor economist. She advocates strongly for such measures as mandatory, professionally managed retirement accounts.

I have no interest in wading into a policy debate here, but I do have one initial reaction to this. While Ghilarducci's proposal no doubt helps to address the problems of the world as it actually is, I still dream of the world as it could be.

Setzfand at the AARP argues that we need to aim for financial capability, not just literacy. The distinction she draws is that literacy alone is not enough if it does not lead to sound actions with positive outcomes. In order to achieve a common foundation of financial capability among Americans, she argues that we need to introduce financial education into the K-12 school system, and carry that education through to universities, workplaces, professional organizations, and other areas of our lives where we naturally interact.

We share Setzfand's dream of a more financially capable public, and we have faith that you can seize control of your financial future. Here are four things you can do right now to begin getting your retirement savings in order.

  1. Calculate your number. Don't worry, you don't have to pull your old algebra notes out of the attic. Other kind souls have done the heavy lifting for you, and published free retirement calculators like this one online. If you want something more heavy-duty and you don't mind paying for it, try Putnam's Lifetime Income Analysis Tool which, starting next year, will integrate detailed health factors into its calculations.
  2. Read and understand your statements. You pay fees for the management of your 401(k). If you're like most people, you probably don't know what those fees are, and how they compare with other fund options. That's because, ever since the inception of 401(k) plans, fees have not been disclosed in a manner that the average investor could understand. In the Department of Labor's sweeping set of new disclosure rules, that is about to change. You will receive a statement in the mail sometime this fall with full information about exactly what fees you're paying. Read it, take it seriously, and shop around to see if you're getting a good deal.
  3. Schedule an appointment with human resources. Find out what plans your employer provides for your retirement and enroll immediately if you haven't already. If your employer offers matching contributions, max them out, or you are literally giving away free money. If you're already invested, see if your HR representative has any tips to help you get more out of your money. Those new disclosure rules also require your employer to assess whether its 401(k) plans are really performing as well as they should.
  4. Optimize your asset allocation. Decisions about how much cash you need readily available and what percentage of your investments should be in stocks, bonds, and other vehicles depend on such factors as your age, lifestyle, health, and more. Further, the optimal balance changes over time with your life circumstances. Take a look at the Fool's Rules for Asset Allocation to see if you're on the right track.

No matter the state of your retirement planning, these four steps will set you on the right path. You deserve a happy retirement!

For additional articles in this series, click on the following links: