The 411 on 401 plans - k

Black Enterprise, April, 1993 by Carolyn M. Brown

Unlike Social Security, no one is "entitled" to a pension. Yet about 70% of public and private sector employers sponsor these retirement vehicles for their workers. Today, private pension plans pay annual benefits of nearly $141 billion - and account for 17% of all income for people age 55 and older. No matter what your age, then, these figures beg the question: "Do you have a grip on where your pension dollars are invested?"

Most folks earn their pensions in one of two ways: through defined benefit or defined contribution plans. The former provides a set annual benefit, paid entirely by the employer, based on salary and years of service. Defined contribution plans, such as 401(k) and profit-sharing programs, require employees to earmark a percentage of their wages to go toward the plan.

Given an aging U.S. work force and the high costs associated with employer-funded pension plans, more companies are turning to defined contribution programs. To date, says the Labor Department's Pension and Welfare Benefits Administration, over 100,000 such pension plans cover 19 million people.

Many people, however, are intimidated by the notion of tending their own pension investments, and thus play a passive role in how their funds are handled. That could soon change. New provisions under the Employee Retirement Income Security Act (ERISA) give employees greater choice and flexibility in pension plans in which they direct their own investment decisions.

Under the new rules, participants must be able to: * choose from at least three investment alternatives, each of which has different return characteristics. * diversify investments to minimize risk of large losses. * switch investments at least once every three months. * obtain sufficient information from their employer to make informed investment decisions.

The new ERISA rule, effective Jan. 1, 1994, isn't mandatory. But pension plan sponsors, trustees and managers who do comply can't be held liable for participants' bad investment decisions. However, employees may be able to sue their companies for poor performance of investments if the plan fails to meet any of the above requirements.

By easing the burden placed on fund managers, Labor Department officials anticipate that by the end of 2000, the number of 401(k) plans will climb to at least 165,000, compared with 100,000 today. The bottom line: Whether you already contribute to or intend to participate in your company's 401(k) program, you'd better get the latest dibs on your retirement funds.

"Workers will have more say in how their pension money is handled" says Cindy Hounsell, staff attorney with the Pension Rights Center in Washington, D.C. "But it also means that they'll have to become more informed about the various types of investments available."

Sizing Up Your Options

The first step to winning the pension game is to make sure you're in it. The number of employees eligible for 401(k) plans, for instance, is up from 7 million in 1983 to more than 40 million today. Yet, surveys show that fewer than half of those workers actually participate.

"Employees who aren't contributing to salary reduction plans should ask themselves, 'Can I afford not to?'" says Charles Ross, an Atlanta-based certified financial planner.

The answer is, "probably not," given the general rule that most people should sock away between 5% and 10% of their incomes annually for a comfortable retirement. But in these days of job-hopping and layoffs, most departing employees raid their pensions and blow the entire wad, rather than saving it. Considering the opportunities for your pension's tax-deferred growth, such a move is unwise. The maximum annual contribution for a 401(k) plan is $8,728 (this limit rises each year with inflation).

Even those who do participate often fail to invest their pension funds for maximum gains, says Pierre Dunagan, an account executive with the brokerage firm of Dean Witter Reynolds Inc., in Matteson, Ill. As proof, he points to the millions of 401(k) participants who are heavily invested in guaranteed investment contacts (GICs). GICs, also known as capital preservation or "fixed-income" accounts, are instruments issued by an insurance company that guarantee a set interest rate,similar to a bank certificate of deposit.

So before you choose any investment option, take stock of all of your retirement savings, suggests Roberta Berger, co-owner of Capital Control Concepts, a financial planning and investment advisory firm in Englewood Cliffs, N.J. Think of your pension plan as the place to round out and enhance your retirement portfolio.

Most companies offering 401(k) plans allow employees to invest pretax dollars into bonds, GICs, stocks, mutual funds or insurance certificates. The company normally matches 50 cents for every dollar, or up to 6% of your earnings, and the money accumulates tax-free until withdrawal, usually upon retirement.

Compared with other investments, equities (i.e., stocks), offer the best potential for long-term growth. In fact., stocks making up the Standard and Poor's (S&P) 500 have gained an average of 10% since 1926.