Personal Finance: Is Your 401(k) Worthless?

Forget the formerly-funny 201(k) jokes. Nobody's laughing about the grim state of their retirement plans now. Employees who've watched their balances fall are getting bitter, and who can blame them? The once-vaunted employer-sponsored defined contribution plan may be failing them. Employers aren't much more upbeat. Some have even dropped their matching contributions in recent months.

"It's been a very difficult environment for everyone," says David Huntley, a Baltimore analyst whose company, 401k Source, monitors these plans. "Participants, employers and companies in the industry have all taken a hit."

The really bad news? It could all get worse before it gets better. Most experts agree the market will recover and stock funds will regain value—eventually—and so they argue that 401(k) plans remain a powerful tool for retirement savings. But the days of assured growth are over. Employees need to be more familiar with the funds they are investing in through their plans, and more aware of the total fees they are being charged.

A quick recap: The 401(k) plan rose to prominence in the 1980s as a way for companies to offer their employees retirement benefits without taking on the liability of a fully-funded pension plan. Employees set aside their own pre-tax dollars and employers typically matched some percentage of those contributions. (Employers who had been paying roughly 7 percent of salaries to cover pension plans, began spending 3 percent in those matching contributions instead.) Employees chose where the money would get invested (off of a menu created by their employers.) For a while, especially during the dotcom boom of 1999, everyone was riding high.

Then came trouble. First there were problems with too many employees holding too much (bad) company stock in their 401(k) plans, a situation which came to a head during the Enron mess. Then came a slew of employee lawsuits in 2006, aimed at employers who were filling their investment menus with high-fee mutual funds that shifted the costs of managing the retirement programs away from employers and on to the workers. Now, with the stock and credit market crisis of the last year, a whole other round of 401(k) problems have come to the fore.

For starters, the median 401(k) investor lost 28.3 percent of their account's value in 2008, according to a study by Hewitt Associates - and that was before the Dow Jones Industrial Average dumped another 25 percent of its value in the first quarter of 2009. Some of that has come back, of course, but just at a time when workers might think they should be investing more in the beaten-down market, a number of big-name employers (General Motors, Boise Cascade, Frontier Airlines, Cincinnati Bell, etc.) suspended their matching contribution programs. Adding insult to injury, some employees who had been contributing to their own 401(k) plans found their money frozen in mutual funds they thought were super safe when the funds couldn't sell enough assets to cash out workers who wanted their money back.

Then there's the money being pulled out of the accounts. In 2008, almost one of every five employees took hardship withdrawals out of their account, and another 23 percent borrowed money from their own fund, according to the Hewitt study. It's hard to tell whether these workers simply needed the cash or were disgusted with the whole 401(k) situation.

Still other questions remain. With balances down, employers cutting their contributions and new estimates showing Social Security is more vulnerable than previously thought, how will workers afford retirement at all? Will vendors - the companies that provide the mutual funds and other investments that appear on employer menus – raise enrollment costs to offset losses due to falling fund balances? Could there be a wholesale retreat from 401(k) plans if the situation deteriorates any more?

Not according to loyal 401(k) advocates who say that every misstep is a chance to learn a lesson and improve on the plans, which, as the preeminent retirement savings system now, aren't going anywhere. "You have events and you respond by improving the system, says David Wray of the Profit Sharing/401k Council of America, an organization of plan-providing employers. "There is a lot of conversation now, but the argument is not about whether there should be a defined contribution system or not, it's how that system should be managed and structured."

The Labor Department has been working on fee-disclosure rules for years; its efforts might be eclipsed by legislation from Rep. George Miller (D-California), chairman of the House Education and Labor Committee. He's sponsoring a bill that would require more transparency of plan fees. His bill would also require employers to include an inexpensive index fund on their menu of investment options. The Obama Administration has talked about requiring employers to enroll workers in 401(k) plans or offer private contributions, but backed off of that plan in its latest budget proposal. Workers whose companies aren't offering any matching contributions may turn to their other tax-favored savings options, such as deductible Individual Retirement Accounts or a Roth IRAs, to amass assets for retirement.

Finally, employees with 401(k) plans have to be more vigilant in protecting themselves, say experts like Chris Lyon, of Rocaton Investment Advisors, a consulting firm which advises employers. In this economically challenging environments, employees should steer clear of funds that are too complex to understand or that make money by lending securities to other institutions, as they may become illiquid. Investors should also monitor their management fees, either by checking funds at Morningstar, or by asking their employers how much they are paying for their 401(k) investments.

Such common-sense cautions aside, most pros remain convinced that employees are best served by continuing to invest in their 401(k) accounts, and by directing much of that investment into stock funds for the long haul. And that appears to be just what we are all still doing. Fidelity Investments, a big provider of 401(k) plans and investments for employers, reported last week that 97 percent of their 401(k) participants continued to make contributions through the first quarter of 2009, and that two-thirds of their contributions were going into stocks and stock funds. A recovering stock market would lift their balances and perhaps their level of satisfaction with the whole 401(k) concept. Who couldn't use a couple of good "501(k)" jokes about now?