Keeping Your 401(k) Flameout-Retardant
By Ellen Hoffman
Thanks to Enron, we all know that having too much company stock isn't smart. Whether you accumulated a ton of it by choice or because that was your only opportunity for 401(k) matching contributions from your employer, you need to look at how much you have. Most experts say if it represents more than 10% of your total investments -- not just your 401(k) -- you should immediately start to diversify.
Mark Wilson, a Newport Beach (Calif.) financial planner, says the publicity about Enron is helping him address "the hardest thing we wrestle with" -- convincing clients of the risk of concentrating retirement funds in employer stock. Too often, he says, investors have emotional ties with the company. And as long as the stock is performing well, he adds, employees feel that everything is just fine. But the Enron experience has "set off a light bulb," as Wilson puts it, that's making it easier to convince clients to diversify.
Even if you're confident your employer is no Enron and you think you're safe with a higher percentage, federal law may make you think again. Traditional retirement plans that guarantee a pension can't have more than 10% of the plan's assets in company stock. But the government has set no limit for 401(k)s or similar employer-contribution plans.
Also, if you have a traditional pension and your employer goes bankrupt or is bought out, the federal Pension Benefit Guarantee Corp. (PBGC) guarantees that you'll still receive your pension. But the government doesn't guarantee or insure the money in a 401(k), so the risk is all your own. (To learn more about how PBGC protects pensions, see its Web site at www.pbgc.gov/.)
Here are some tips on what you should do:
Figuring Risk. To see if you're overstocked, pinpoint how much of your money and your financial future is tied to the company. Don't make the mistake of looking only at your 401(k). Be sure to add up your employer's stock in other accounts, such as a profit-sharing plan or a regular brokerage account, as well as stock options. And don't forget your salary. "If your company falls on tough times," points out Pine Plains (N.Y.) financial planner John Henry Low, "the stock price will tumble at the same time you're at risk for a layoff."
Alternatives. Your opportunities for diversifying within the 401(k) will be limited by the rules of the plan, so ask the human-resources department or plan administrator whether policies prevent employees from selling some of their stock before reaching age 55, or whether lockout periods or other restrictions apply about when you would be unable to sell the stock. Even if you face some restrictions, you can stop your voluntary purchase of company stock immediately and put that money into mutual funds or other investments.
Tom Gryzmala, a financial adviser in Alexandria, Va., says "every plan should have at least a stock fund, a bond fund, and a money-market fund, and if you don't have at least one of each, speak to your human-resources department" about adding more investment options.
Michelle Hoesly, a retirement-planning specialist in Norfolk, Va., says a common mistake is putting money made from selling company stock into the same industry. "Often people will pick mutual funds in an area they understand, and often that's the same type of industry they're working in." But you'll be safer if you spread the investments among different sectors, she says. She advises you to devise a selling strategy based on what you think is happening with the stock market overall, as well as with your industry and occupation.
When to Sell. If you have a profit, Gryzmala suggests that you "take that profit off the table" by selling the stock as soon as possible. If the stock has been lagging or has been volatile, other financial planners I interviewed have suggested "dollar-cost averaging," meaning that you sell, say a third or a fourth of the total at a time, on days when the price is relatively attractive.
Tax Tip. As long as you're selling stock within the 401(k), you won't have to pay capital-gains tax. But if you've also built up a big stash of employer stock outside your retirement plan, ask your tax adviser for help in minimizing the taxes -- perhaps by spreading the sales over two different tax years. For tips on the tax implications, check out this Web site: taxes.yahoo.com/guide/execcomp/buying.html.
Amassing company stock can be seductive. Employees often believe they're in a position to accurately assess their employer's financial health. If a company has had a few banner years, it's easy to start viewing high returns as the norm and expect that big gains will continue. That also makes investing in company stock appealing -- even though you're buying when the stock is high, perhaps artificially so. And, as happened with Enron, management may be too "reassuring" about the company's long-term prospects.
The Enron debacle has prompted Congress to consider changing 401(k) rules to head off similar problems. Several different committees have been working on legislation, some of which is being considered on the House floor this week. But take the time now to figure out if you have too much invested in your company -- before Congress, or events, force you to get involved.
Hoffman writes Your Retirement only for BusinessWeek Online. She's the author of The Retirement Catch-Up Guide and Bankroll Your Future Retirement with Help from Uncle Sam, and you can contact her through her Web site, www.retirementcatchup.com
Edited by Patricia O'Connell