It's Time To Start Coddling Your Nest Egg

When Washington's tax wizards created section 401(k) of the Internal Revenue Service code back in 1981, they changed the concept of retirement forever. Since then, more than 60,000 old-style company pension plans have been dismantled in favor of the defined-contribution approach. These 401(k) plans are loaded with tax breaks, and they put employees in control of their savings. But even after 10 years of evolution, most 401(k) plans leave much to be desired.

Although companies have shifted the burden of retirement financing to their employees, many fail to help them make informed decisions about saving and investing. A 401(k) plan can provide security only if employees understand how to maximize their savings. "If you buy a mutual fund, you get a prospectus," says Richard VandenBrul, president of 401(k) Advisors Inc., a Livonia (Mich.) consultant. "But with 401(k) plans, there are no standards."

`AMAZING.' The typical plan's strongest feature is its combination of tax advantages and company matching. Employees set aside a percentage of pretax salary in each pay period and invest it in one or more funds, where the money grows tax-deferred until it's withdrawn at retirement. Many companies match employee contributions, in whole or in part. After several years, employees are vested in the company's share as well as their own. Arthur Urciuoli, director of Merrill Lynch's Business Financial Services, calls a company-matched 401(k) "the amazing double-your-money subsidy."

Yet average participation in such plans is less than 75% at companies that offer them, according to Buck Consultants, a New York firm that tracks benefit trends. And this is where experts see the most room for improvement. In many cases, employee education about benefits programs is so poor that workers don't know to enroll.

If you're lucky enough to work for an employer whose 401(k) plan is co-managed by a tried-and-true benefits consultant or mutual-fund family, you're more likely to get the information you need. Putnam, for example, customizes a four-part brochure for its clients, explaining the 401(k) plan's investment options and service features, and throws in a "calculator" that shows how much you'll have at age 65 if you sock away, say, $200 a month starting at 30.

Going a step further, Fidelity Investments publishes a quarterly magazine for participants in plans it helps administer that addresses issues such as the tax consequences of borrowing from your 401(k) funds for a downpayment on a house. And benefits consultant Towers Perrin offers a user-friendly software package that's customized for different corporate plans and helps workers project the amount they'll need when they retire.

Charles Salisbury, managing director at T. Rowe Price Associates, believes plan sponsors are waking up to the need for better communication. Employers used to worry that giving investment advice would lay them open to lawsuits if employees lost their shirts. Now they realize that failing to promote and explain a 401(k) plan could be a much bigger liability if workers find themselves retiring penniless.

For instance, Merrill Lynch's Urciuoli thinks a benefits officer's No. 1 priority should be impressing upon employees the need to join early. Many workers still don't realize that, thanks to the miracle of compounding, a 50-year-old who starts putting away $500 a month toward retirement will never catch up with someone who began saving $100 a month at 30.

SHORT MENU. Even fewer employees have the knowhow to allocate their savings among a plan's various investment options without guidance. The majority of companies offer three or four choices--usually, a money-market fund, a fund made up of insurer-underwritten guaranteed investment contracts (GICs), and a managed equity fund that's often tied to a stock index. Many employees put the bulk of their contributions into whatever they believe is safest. For people only a few years away from retirement, vehicles that guarantee the principal make sense. But younger savers who avoid the stock market give up rich returns, because stocks historically outperform other investments over 10 years or more.

Robert L. Reynolds, president of Fidelity Institutional Retirement Services, says that 401(k) participants stick an average of 70% of their money into money-market or insurance options. "For a long-term investment strategy, that's way too much," he says. Fidelity makes sure its participants understand the concept of dollar-cost averaging: When you invest the same amount of money in stock on a regular basis, you lower your average cost of shares, because you're buying fewer when the market is up and more when it's down.

Sophisticated savers have a different frustration: the limited range of 401(k) investment options. Only a fraction of plans offer funds that include foreign equities or domestic growth stocks--even though financial planners agree that around 10% of a well-diversified portfolio should be in such securities. And some companies put a disproportionate amount of 401(k) equity funds into their own stock--a risky bet, unless you happen to work for the highflier of the decade.

Experts say companies are slowly beginning to expand 401(k) investment choices. One reason is last year's scare over insurer solvency, which prompted them to take a harder look at their "guaranteed" investment contracts. Another is low interest rates, which have depressed yields from money-market funds. And the government is about to finalize proposed Employee Retirement Income Security Act (ERISA) regulations that will require 401(k) plan sponsors to provide a menu of investment options that will satisfy a broad range of needs.

No such rules tell companies how often they have to let employees shift their investments around or change the amount they save. But here, too, the trend is toward greater flexibility. Most companies now allow quarterly changes in investment allocation; a few allow them monthly. Towers Perrin has an interactive, 24-hour phone system that gives clients' employees daily fund valuations and lets them change their investment mix or savings level by Touch-Tone. The consultant believes that such electronic systems are the wave of the future, as plan participants demand more disclosure and control.

LOAN LIMIT. Another major concern for employees is their access to plan contributions. Withdrawals from the plan before age 59 1/2 carry a 10% IRS penalty on top of income taxes, but a growing number of plans have loan provisions that let you tap funds before retirement without penalty. The government limits how much you can take out: It can't be more than half of your vested account. But companies vary widely on how little and how often you can borrow, the interest rate, and whether you pay the interest to yourself.

Plan sponsors in general want to discourage borrowing from 401(k) funds, because loans add to their administrative burden and work against the plans' purpose. Still, companies are realizing that omitting loan provisions--or keeping them secret--scares away participants who worry about locking up their money.

With all the shortcomings of 401(k) plans, would you be better off saving for retirement on your own? No way, say the pros. To beat the benefits of tax breaks and company matching, you'd have to be an investment genius. But if you think your plan needs improvement, you can lobby for change. That worked at companies such as Honeywell Inc. when employees found out that their GICs were underwritten by Executive Life. And if benefits officers don't come to you with information, go to them. Remember, companies are saving millions by abandoning the old-style pension. Now, your retirement security is in your hands.

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