Like a summer bungalow now being lived in year-round, 401(k) plans are being called on to serve a function never anticipated by their architects when they drew up the blueprints more than 30 years ago.

When Congress amended the U.S. Internal Revenue Code in 1978 to make 401(k)s feasible (see timeline page 48), the plans were expected to act only as a supplement to the defined benefit plans then-popular among employers as part of a three-pronged approach that included Social Security.

But since then, as financially strapped employers have moved away from defined benefit plans, 401(k) plans in many cases have become employees' sole retirement savings plan, a role the plans were not intended to serve.

The plans' design has changed considerably over the years. Large numbers of employers in recent years have added life-cycle or target-date funds to reduce investment risk for older employees.

In addition, a majority of employers now provide automatic enrollment in which workers are automatically enrolled unless they object.

At the same time, many plan sponsors have beefed up investment education programs and improved 401(k) plan communication programs.

But today's 401(k) plans reflect a host of problems. Account balances devastated by the recession because of their high proportion of equity investments have led many employees to delay retirement for years, if not indefinitely, observers say. Other problems include inadequate financial contributions as well as withdrawals or loans by unsophisticated or short-sighted employees.

There are proposed changes in 401(k) plans' structure, though, that would help address these issues, observers say. They include easing regulations so employers can more easily offer annuities as part of their 401(k) plans (see story), removing limits on money contributed to 401(k) plans and simplifying regulations for plan sponsors.

Robert McAree, New York-based senior vp, and retirement practice leader for Sibson Consulting, a division of Segal Group Inc., said 401(k)s were established primarily as “capital accumulation vehicles that individuals would draw down in retirement to essentially supplement a pension.” In their current state, though, they were not “well-equipped to satisfy the primary retirement needs of individuals.”

Jack A. Abraham, a principal with PricewaterhouseCoopers L.L.P. in Chicago, agreed. For an employer-based system to survive, we “need changes in structure to provide new types of designs that give employers more flexibility” and mitigate employees' investment and longevity risk.

Many observers say they would like regulations changed to make it easier for plan sponsors to have at least part of workers' 401(k) plan assets put into annuities.

While automatic enrollment has been highly effective in boosting participation, observers say they would like to see the cap on automatic escalation clauses in 401(k) plans removed. The Pension Protection Act of 2006 limits deferrals to 10% of salary.

Forty percent of plans that automatically enroll participants also automatically escalate contributions, according to a 2009 study by Lincolnshire, Ill.-based Hewitt Associates Inc., which Aon Corp. said last week it plans to acquire in a $4.9 billion cash-and-stock deal.

Greg Burrows, senior vp of retirement and investor services with Des Moines, Iowa-based Principal Financial Group Inc., said he would like plans to be able to remove the 10% salary deferral cap and allow employees to “take as high (a deferral) as they can within the plan design.

However, “I don't think many employees would take advantage of that” if the 10% cap were removed, said Vita Amadeo, team leader with Willis Retirement Services, a Cranford, N.J., unit of Willis Human Capital Practice. “You get to the point where how much is too much, and how many employees can truly elect to save more than 10%, and is it really the employer's place to make that decision?”

Another suggestion is to remove the federal maximum, currently $16,500, that workers can contribute annually. “That would be one easy adjustment,” Ms. Amadeo said.

Some observers also advocate eliminating the annual $5,500 catch-up limit for workers 50 and older.

Greg Markle, vp and chief operating officer at Romulus, Mich.-based plastics manufacturer Spiratex Co., said young people may not participate in their employers' 401(k) plans in many cases because it “takes a back seat” to buying a house or a car or starting a family.

If they do want to catch up, they may “start hitting ceilings that are imposed because of 401(k) limits that are put on by the government,” said Mr. Markle, whose company's 401(k) administrator is Principal Financial.

Arthur Conat, Chicago-based executive director, performance and rewards practice at Ernst & Young L.L.P., said he believes “there could be some basis for going back and recapturing” what workers had not invested in previous years because of competing financial needs.

Simplifying administrative rules also would be welcome, observers say.

“I think from an employer standpoint, I would love to see less kinds of government intervention,” said Jette Jensen, office manager for Concord, Calif.-based Eichleay Engineers Inc. of California. The firm must conduct continual tests to make sure it is in compliance with government regulations, she said. The company, whose 401(k) administrator also is Principal Financial, has 246 participants in its plan, Ms. Jensen said.

“Leakage” of funds from 401(k) accounts with a job change, a loan or as a hardship withdrawal is a significant problem as well, say observers. Young people who withdraw their 401(k) balances as they switch jobs every few years “are going to get to retirement with nothing saved,” said Pamela Hess, director of retirement research at Hewitt Associates in Lincolnshire.

“It seems kind of silly” to let workers take money out just because they are changing jobs, said Ms. Hess, adding she would like to make it more difficult for them to do so.

Under current law, a 10% penalty is imposed on most distributions taken prior to age 591/2 in addition to taxes.

A related issue is loan withdrawals.

A survey of Fidelity Investments' active participants indicates that 21.3% have taken out loans on their 401(k) balances as of this year's first quarter, said Beth McHugh, Covington, Ky.-based vp of market insights for the 401(k) administrator. “We want to see that trend begin to go downward because...it impacts your ability to compound and the ability of those assets to grow,” she said.

“Too often, people think of these plans as being kind of Christmas clubs, almost,” rather than future retirement plans, said Alan Vorchheimer, a New York-based principal for Buck Consultants L.L.C.

Limiting withdrawals can be problematic, though, say some observers. The ability to take out loans “may encourage people who may not otherwise contribute” to firms' 401(k) plans to do so, said Bill McClain, a Seattle-based principal with Mercer L.L.C.