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The 401(k): A rip-off of workers or a savior?
Published Aug 7, 2002 401K07
The 401(k) isn't just taking a beating from the stock market. There's increasing criticism that the rise of the savings plan and the decline of the traditional pension will leave more people in financial straits in retirement.
"It's a worker rip-off," said Edward Wolff, a New York University economist who studied retirement wealth of households nearing retirement.
Wolff's study, published recently by the Economic Policy Institute, found that the 401(k) benefited the wealthy, who have more disposable income to salt away in the plans. But the 401(k) led to an 11 percent drop in retirement wealth for the typical household from 1983 to 1998, despite the bull market.
As of 1998, nearly one in five households faced the prospect that their retirement income will be below the poverty line, Wolff found. And 42.5 percent of households were expected to have less than half of their current income in retirement, up from about 30 percent in 1989.
William Wolman, co-author of recently published "The Great 401(k) Hoax," also criticizes companies for adopting inexpensive 401(k)s, which shifted the risk and critical investment decisions from employer to workers.
When the economy soured, some companies cut their matching contributions, he said.
Pension vs. 401(k)
Some academics disagree with Wolff's methodology and defend the 401(k).
They point out that many employees never qualified for a pension because they switched jobs too often. And not all pensions offered generous benefits.
"I would take the 401(k) plan, thanks," said Jonathan Skinner, an economics professor at Dartmouth College.
Skinner co-authored a study last year that compared how workers with pensions in 1983 would have fared with a 401(k).
In simulations that excluded the 1990s bull market and included workers' bad investing habits, employees still ended up with more retirement income with a 401(k), Skinner said. The median annual benefit was $9,227 for the pension compared with $12,694 for the 401(k).
The 401(k) fared better largely because the money can be invested in the stock market, which historically has a higher return than a pension provides, he said.
For many workers, the question of which retirement plan is better is moot. Pensions are disappearing and a 401(k) might be the only option. "It's nice to look back on the good old days," said Joel Ticknor, a Reston, Va., financial planner. "But it's not there anymore."
Even 401(k) critic Wolman said, "You have to participate in your 401(k)."
At the end of last year, 401(k) assets totaled $1.58 trillion, a 6 percent drop from the year before, Spectrem Group reported. The latest figures also show that workers haven't reduced their contributions, although they have been shifting money from stock to bond funds.
Steps that workers can take to boost their balances and retirement prospects over the long run include:
Increase contributions: Wolff estimates that workers saving at least 10 percent of pay in a 401(k) over 40 years could replace 50 to 60 percent of their preretirement income. Along with Social Security and other savings, workers could have a retirement income equal to about 80 percent of preretirement income, allowing them to maintain their standard of living, he said.
Create a 401(k) club: Novice investors learn about the market by joining investment clubs, where they research stocks and buy shares as a group. Wolman suggests co-workers form similar clubs for their 401(k)s. He said members can keep up with what's happening with the plan and lobby an employer for, say, better investment choices or lower administrative costs.
Develop a plan: "One of the mistakes people are making is they are trying to make long-term investment decisions without the benefit of doing any planning," said Fred Cornelius, a financial adviser in Rockville, Md. They don't know how much they need for retirement, or what their investments must earn to reach their goal, he said.
By planning, he said, workers might discover that they don't need to invest as aggressively, that they must save more or should readjust retirement expectations.
Diversify: Workers have only to look at Enron Corp. to see the dangers of investing too much in an employer's stock. Some financial planners suggest limiting ownership in company stock to 10 or 20 percent. Cornelius advises against owning any employer stock in a 401(k), provided the plan doesn't restrict the sale of company shares.
"That ties up your financial fortune too much in the company," he said. "Let's face it, if you lose your job because the company is doing poorly, chances are your stock is going down as well."
If you want to own company stock, do so outside the 401(k), Cornelius said. That way if it skyrockets, you can sell it and pay capital gains tax on the profits, rather than ordinary income tax, which is probably higher than the rate applied to 401(k) withdrawals.
A well diversified account holds large-cap, mid-cap and small-cap stock funds, growth and value and domestic and international, experts said. Also, don't overlook bonds.
Choose low-cost funds: Workers often aren't aware of the fees charged by the mutual funds in their 401(k)s, but, "It's draining their returns," said Annette Simon, a Bethesda, Md., financial planner.
Check 401(k) funds' expenses at Morningstar Incorporated's Web site, http://www.morningstar.com.Anything above 1 percent of assets for an actively managed domestic fund and 1.5 percent for an international fund is too high, Simon said. The expenses for index funds, which passively track a benchmark, shouldn't exceed 0.3 percent, she said.
Avoid borrowing: Plans usually permit workers to borrow against their 401(k) account and repay the money with interest. Workers might need to tap the 401(k) in an emergency, but should avoid treating it like a revolving credit line. "While the money is not there, it's not growing, and you're always playing catch-up," Simon said.
Similarly, don't cash out a 401(k) when switching jobs, but roll it over into an individual retirement account or the new employer's plan, if possible, so the nest egg keeps growing.
Review annually: Make adjustments if needed. "For most people, managing their own money once a year is fine, just to re-balance, look in the mirror and say, 'My life situation, has it changed?' " Ticknor said.
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