The 401(k) Returns... Almost

Your 401(k) is still in trouble. As the stock market rallies (although some think that September and October, historically bad months for the stock market will correct this), as the economy recovers (although consensus agrees for the most part that the recovery is not so much a bounce as a leveling off) and as unemployment remains the lagging indicator (along with housing), the effort at funding your future through your 401(k) languishes. Why? The employer is seeing that incentive to invest, the 401(k) match as not worth reinstating to pre-2008 levels.

For those of you who may not be aware, the 401(k) replaced the pension decades ago as companies divested themselves as guardians of your future. Pensions were the repayment for loyalty, human capital and profits. The 401(k) on the other hand was directed by the employee. Business used the incentive of the company match, a dollar for dollar investment up to a certain percentage as a way to encourage loyalty, human capital and profits.

Then the economy turned sour. And in the process of cost cutting, many companies eliminated or greatly reduced their company match. The question is: will matching of employee contributions ever return?

The short answer is yes. The long answer is: they will no longer resemble the employer contributions we have all become used to receiving.

Businesses face two problems when they decide to cut their 401(k) match. Neither is very appetizing and may even cost the company more than they bargained for.

For most plans, reinstating their 401(k) will not happen until 2011. Because of what is known as a safe harbor rule, reinstating the company match needs to be in the books by November of the previous year. To take effect in 2010, companies will need to feel as though the economy is on stable footing. This is not yet clear and may not be clear by the fall.

If the economy recovers at a faster pace than anticipated and jobs begin to return before 2011, the competition to get and in many cases retain good employees by offering these incentives will be missed. This could be a costly mistake for businesses looking to get and keep quality workers.

If the economy merely levels off, these employers will have time to see if some new techniques, currently being offered by Starbucks, might be the way of the future. Starbucks is breaking the mold for 401(k) plans by changing the incentive to profit based contributions. In other words, the company does better and in return, you get something for your retirement besides what you invested.

Will it work? Will other businesses follow? Possibly yes to both. The current corporate thinking is leaning towards less incentives believing that their plans were too generous in the first place. If your company has struggled through these tough economic times, particularly if you are associated with the automotive industry, those incentives, many experts agree, will never return.

A great number of other industries are planning to ease back into the incentive by offering substantially less in matching contributions and promising to raise those levels once they are assured the economy has recovered.

Some may simply be waiting to see of the Starbucks model works.

Does this mean the end of the 401(k)? No. Instead, you will have to earn more, put away more and invest with slightly more risk than you would like to assume. This means keeping your money out of staid index funds and target-dated funds in favor of investments that could do better. For some, this will be re-entering a high-risk investment model that did not pay off previously, evidenced by the cutting many nest eggs by a third or more when the market soured.

The next year will prove to be among the most interesting of the recovery.

Retirement Planning: A Good Retirement Plan (401k) Gone bad

Despite all of the faults with your 401(K) plan, from poor or limited choices, forced matches with company stocks, high management fees to name just a fee, your plan may not be getting any better soon. Is waiting around for improvements worth it?

The Company Match
The incentive called the company match may have been tossed to the wayside in this current economic cycle. And for good reason. Many business were forced to take drastic measures to stay afloat as consumers spent less, credit got tighter (for both their customers and capital expenditures) and labor costs seemed to rise (although in truth, they didn't actually go up as much as sales went down).

The 401(K), created for allow for additional savings for wealthier individuals looking to add to their retirement accounts in the presence of a fully funded pension plan, has been misused by many of the folks who are enrolled. As a self-directed plan (defined contribution plan), the responsibility of the employer to provide you some reward for years of service and your precious human capital diminished (the plan need only present you with choices), offer some advice (albeit generic), and direct non-participant employees to a default investment (as per the poorly written Pension Protection Act of 2006 - a misnomer if there ever was one).

The company match, a contribution by your employer that offered you free cash for every dollar you contributed on your own, up to a certain percentage (most commonly 3%) has been halted or scaled back by many employers. Some have switched their matching rules to include only stock with rules that make moving the plan more difficult.

Even if your company no longer matches, continue to participate in the plan. The pre-tax incentive is enough to make the plan worthy of your money. How much is often the questions I hear the most. And the answer is relatively simple: a 5% contribution to your plan will probably net you the same after tax income that you would have received had you made no contribution at all.

What's in the Plan
Companies have been forced to scale back or change plan administrators. In some cases, this is warranted. Many plans had too many options and far too frequently, contained products that were ill-suited for the average investor (although in many instances, the average 401(k) investor confused what they were doing as savings and because of that confusion, made them less-than-average participants in the plan).

Determining the worthiness of the underlying investments is even more difficult. Some companies offer a lot of funds; some only a few. Some offer a wide variety of mutual funds across a wide spectrum of possible investments; some offer only a group of index funds focused on specific types of investing (large-cap through small-cap, growth through value through balanced, and target-dated funds).

One of the most fundamental aspects of a well-constructed plan is not eliminating too much risk. Because the plan is built on a 'pay the taxes later' concept, there should always be a certain level of risk involved. I have long been an advocate of keeping investment mainstays such as the S&P500 index funds on the outside of your retirement plan. Doing so will force you to pay the taxes on the fund now, rather than later and because capital gains taxes are still historically low and the fund is very tax-efficient, paying the tax now will give you all of the money in the fund whenever you need it.

Fees are a Consideration
Always compare a fund against its peer group rather than against some index for more than just performance. Most fund managers want you to look at an index that, in most instances, does not reflect what they are trying to do. Take for example the S&P500. This index is not necessarily considered a growth sector. Although there are companies in the index that are growing, the largest in that group are dividend paying (often) behemoths that might be better categorized as value plays.

But fees that are too high, as compared to their peers, act as an additional drag on your investment. The best way to get these funds out of the plan is to complain. If the plan is charging fees that are excessive, employers might be paying too much as well and employees might under-participate in the plan because of it.

Self-directed is not the same as set-and-go. In fact, the more control you have over your investment decisions, the more difficult it becomes. Take a moment to review our examination of why investors do what they do and how you can benefit from a new approach to your plan.