Account down: if you think you're going to retire on your 401(k), think again.

MORE THAN 42 MILLION Americans, one in three with a job, have a 401(k) plan to defer part of what they make today for their old age. Survey after survey shows that Americans love their 401(k) plans and, except for the oldest workers, value them more highly than traditional defined-benefit pensions, which pay a lifetime annuity, are largely guaranteed by the federal government, and have been in decline since the 401(k) began two decades ago.

It's easy to understand why. Traditional pensions pay off big-time only if you stay with one company for a career, something fewer and fewer people do. If you switch jobs your benefits are frozen in the dollars of the year you quit, their value eroded by inflation. By contrast, 401(k)s come with a regular statement showing how much you have, and they are portable--when you switch jobs, you can roll your money over into an Individual Retirement Account.

So few Americans have ever had financial assets that getting a monthly statement showing shares of mutual funds can make one feel prosperous. As a leader of the Machinists union told me in May about his members--who all made less than $20 an hour--having a 401(k) plan makes working men think they are capitalists--until their jobs disappear and they have to cash in their mutual funds, paying a 10-percent tax penalty, just to feed the kids and keep a roof over their heads.

Anyone who watched their 401(k) mutual funds plummet 25 percent in the last two years may be wondering if the benefits of these instruments as retirement vehicles haven't been greatly oversold. And they are right to do so. The success of 401(k) plans is a triumph of marketing over sound policy, for despite their portability they are inadequate to the task set for them: to provide reliable income in retirement.

High fees make them inefficient. Contributors are at risk from kleptomaniac bosses. And overall, they are so heavily invested in employer stock--as in Enron and Global Crossing--as to make them a gross violation of the three basics of investing: diversify, diversify, and diversify.

In their generally excellent book, The Great 401(k) Hoax, William Wolman and Anne Colamosca show us how most of us are not so smart as we imagine when it comes to understanding value for our money. This timely book shows the real costs, and risks, of mass innumeracy. And the portrait it paints of the investment skills of most Americans raises serious doubts about the Bush administration's proposal to allow workers to invest two percentage points of their Social Security taxes on Wall Street.

Wolman, recently retired after a long career as the economics editor of Business Week, and Colamosca, a freelance writer who is his wife, skillfully cut through the gloss used to market these plans. The authors present a marvelous synthesis of the literature of the Roaring 20s and relate it to the Soaring 90s, reminding us of Mark Twains observation that "history does not repeat, but it rhymes."

They show how, during a two-decade period of asset inflation, 401(k) plans were marketed as the solution to the financial needs of Americans, who, the authors say, were told that they could prosper from ever-rising stock prices without being cautioned that stocks can also lose value and go for long periods with no growth. Behind the marketing, the authors reveal a larger scheme to relieve corporations of the long-term burden of funding traditional pension benefits and to fatten the bottom lines of Wall Street investment firms. The 401(k) typically costs businesses much less than traditional pension plans, and, not surprisingly, leaves many workers much worse off than they would be under the old system, even with several job changes during their careers.

Special K

One important piece of this story that the authors do not present is how accidents of law, one man's enterprise, and journalism combined to make the 401(k) a household word. The story begins with a 1978 tax bill which, without debate or any public record of its sponsor, added a(k) to Section 401 of the Internal Revenue Code, which deals with pay deferrals.

A smalltime benefits consultant named Ted Benna realized, as did many others in his field, that this little addition opened new opportunities for workers to squirrel away part of their pay. But only Benna, unable to persuade a banking client to adopt a new retirement plan based on the new law, sought a ruling from the Internal Revenue Service on the law's uses. He got a favorable decision, and tried to get news coverage of his idea, only to be rebuffed by both The Wall Street Journal and The New York Times. But Craig Stock of The Philadelphia Inquirer wrote up Benna's idea, prompting a flood of telephone calls. From there, the 401(k) quickly became America's favorite retirement savings plan.

Initially the 401(k) was promoted as a supplement to pensions and as a way to provide retirement savings for smaller employers without such plans. Quickly, though, many companies replaced their pension with a 401(k).

While sloppy news organizations often use the word "pension" when writing about a 401(k), they are in fact very different. In a pension, money is set aside in an investment pool to finance benefits from retirement to death. The employer assumes the investment risk and the government guarantees most benefits. The benefit formula is usually based on years on the job, multiplied by a percentage of salary in the last five years of work. With a 401(k), the worker typically defers money from his or her paycheck and the company matches a portion of it, most often 25 cents on each dollar saved up to a very low limit, often $1,000 or less for the match. The worker assumes the risks of investing with no government guarantees.

Despite all the shares of stock in 401(k) plans, the authors note, the wealthiest 10 percent of Americans still own 85 percent of all stocks. At the end of 1998, half of all 401(k) accounts held less than $16,000. The average balance for people in their sixties was $117,300--hardly enough to get an elderly couple through five years of retirement, much less 20 or 30 years.

These figures tend to be understatements because many people move their 401(k) savings to Individual Retirement Accounts when they switch jobs. (However, five out of six people changing jobs also dip into their rollover, spending some of their nest egg.) While the 401(k) has only been around for two decades, few people are likely to build career-end balances that are much larger than the low six figures simply because so few workers make enough to save much, if anything, during their twenties and thirties.

The authors go on to show convincingly that no matter how you slice the numbers, the 401(k) is not up to the task of providing a secure retirement income, especially in a world in which half of all women who turn 50 this year are expected to live into their nineties. One key problem with 401(k) plans, as opposed to pensions, is that one must make sure to save enough extra money so the funds do not run out before life does. That requires a large cushion for each individual, larger than in the kind of efficient risk-spreading pool that is a pension fund.

Gilded Eggs

Those 20-percent-plus annual gains in share prices in the mid-1990s made many people feel rich. But that was a short-term phenomenon, which, the authors predict, will be evened out by losses or modest gains which may endure for a decade or more.

If stock rise an average of 1.9 percent annually above inflation, they calculate, $1,000 saved today will be worth just $1,457 two decades from now. Consequently, if you saved $10,000 annually from age 40 until retirement at age 65--a mammoth sum for most Americans--and earned 1.9 percent above inflation, you would have $305,000 saved, enough to spend a bit more than $l,200 per month.

Wolman and Colamosca's assessment is blunt: "We believe that the capital gains game envisioned by 401(k) proponents has all the makings of a Ponzi scheme," by which they mean, not that the market itself is a fraud, but that people were lured and continue to be lured into buying stocks at such high multiples of their earnings that many of these 401(k) savers will die before their stocks will grow in value.

The authors do have a practical suggestion for 401(k) savers, one that makes sense for those who expect to tap their funds within the next two decades: Buy bonds.

Fat fees also erode returns. Exxon-Mobil, a company that knows how to wring value out of a dollar, manages its pension fund for less than a nickel per $100 invested, but the authors say that many 401(k) plans charge $2.40 per $100, which is 48 times as much. These fees for investment advice, trading, and record keeping are not explicitly stated, however. Instead, they are subtly bundled into the overall annual returns, making them invisible.

The authors do not dwell on it, but the design of most 401(k) plan statements also can leave participants believing, as the Beardstown ladies did, that they are earning fabulous investment returns when much of the growth in their account balances comes from new contributions, not the market.

Even if the economy does well, a 7-percent annual return above inflation is the best investors can expect, the authors write. Subtract a 2.4-percent annual fee from that and it will take more than 15 years for a dollar saved today to double. (Similarly, for the half of workers who make $26,000 or less, President Bush's proposed 2 percent release of Social Security into private funds would come to just $520 annually. It takes a balance five or six times that amount for an investment house just to cover their costs, and even that requires fees far above the minuscule administrative costs of Social Security.)

The authors also show how 401(k) plans restrict investment decisions, such as timing purchases and sales, in ways that tend to depress returns. Workers in 401(k) plans typically get a narrow range of mutual fund, bond, and money-market offerings picked by management. They have limited rights to shift assets within these choices and often cannot get out if their investment is in their employer's stock, even if it plummets as Enron's did.

And, in many plans, workers' voting rights to their 401(k) shares are severely limited. Management can even vote the stock against the wishes of workers in some cases.

Most significantly, 401(k) plans shift investment risks from employers to workers, many and perhaps most of whom are ill-equipped in terms of knowledge or nature to invest for a financially sound retirement.

Finally, 401(k) plans--and their siblings, the 403(b) for nonprofit workers and the 457 for government workers--work best as one leg of a three-legged stool. The other legs are Social Security and pensions. But for many employers, there is only a two-legged stool wobbling beneath the workforce, a 401(k)-type plan and Social Security. The net result of 401(k)-type plans has been to send the Boomers hurtling toward the winter of their lives without the resources to make this season their golden years.

What to do? The authors suggest raising Social Security benefits. Not likely today. They also suggest revising the laws governing pension plans, which require that these investment pools be used solely to benefit the workers and yet remain the property of employers, creating inherent conflicts. A good idea, but also not likely to catch Washington's attention.

Another option would be more of the new so-called "cash-balance plans," which provide a guaranteed income stream backed by the government, and yet are also portable like the 401(k). These could help make pensions work for a nation of job-hoppers. Unfortunately, cash-balance plans have acquired a bad reputation because some big companies used them as cheapskate replacements for their traditional pension plans.

Even if you are a diligent saver, and turn out to be a brilliant investor, the fact that millions of others are not may become a problem for you. When millions retire with too little to get by they are going to be mad. And like other older Americans, they are going to vote. Washington may then give them more Social Security benefits, tax breaks or other help. And to pay for all of that, what would look more attractive than to tax your nest of golden eggs?

DAVID CAY JOHNSTON is a Pulitzer Prize-winning reporter for The New York Times.