When A 401(K) Is Not Ok

EVERYONE LOVES THE 401(K)-INCLUDING ME, MOST OF the time. Unseen hands pluck money out of your paycheck and invest it for your future, tax-deferred. If you leave the job early, you carry this portable pension with you. More than 22 million workers were covered by 228,000 plans in 1995, according to Access Research in Windsor, Conn. That's the only private retirement plan that a large percentage of them have.

But something is rotten in 401(k)-land, and it's going to cost some trusting employees much of the money they've put aside. These otherwise excellent plans have leaks. Unscrupulous, careless or foolish employers are despoiling some accounts.

Let me hasten to say that most of the 401(k)s today seem safe from harm. Those are the plans where workers can choose their own investments and follow their progress. But for about 20 percent of the plans (some small, some large), the boss or his minions handle part or all of the money. That's where the temptations lie. If the company gets into trouble, the boss might borrow recklessly from the 401(k). If he thinks he can outinvest anybody in the house, he might plunge into risky new issues that don't belong in the average worker's plan. He can even toy with showoff ""investments'' like Persian carpets or Kewpie dolls.

For a good example of what can go wrong, consider the luckless workers at Carter Hawley Hale, which filed for bankruptcy in 1991. They had no investment choice. Their entire 401(k) was invested in nearly worthless Carter stock. And then there's Color Tile, a $700 million floor-covering firm in Ft. Worth, Texas, that entered bankruptcy this year. A committee run by Color Tile's former chairman invested more than 90 percent of the 401(k) in Color Tile stores, according to a lawsuit filed on behalf of the plan. Color Tile didn't return calls. No one knows what the plan is currently worth. The employees can't get their money out.

A generation ago, the same kinds of abuses poisoned traditional pension plans (the kind that pay retirees a monthly income for life). Employers could promise pensions but not provide all the money needed to pay. They could make workers wait for 15 or 20 years to receive any benefits, then fire them just before they qualified. For a while, most lawmakers shrugged off these tragedies as ""small stuff.'' It took a mountain of injury to win ERISA, today's pension-protection law. How big does the next Color Tile have to be, for holders of 401(k)s to win protection, too? Here's an agenda, for any legislator of conscience:

Ban collectibles as 401(k) investments (art, antiques, stamps, gems, memorabilia). They're not permitted for Individual Retirement Accounts, Keogh plans or the 403(b) plans used by schools, hospitals and other nonprofits. So why should 401(k) savers be exposed to so nutty a risk? If the boss wants to cuddle up to a carpet, let him buy it on his own dime, not with money from the plan. I don't care if the plan gets lucky and the carpet's value flies. It's an unconscionable "'investment'' to force on workers of modest means.

Ban employers from putting more than 10 percent of plan money into the company's own securities or real estate. That's already the rule for traditional pension plans. A bill just proposed by Sen. Barbara Boxer, a California Democrat, would give the same protection to a 401(k) if the plan lets the boss make all the investment decisions.

Boxer's opponents are quick to say that the pension law shouldn't be rewritten just because of a smelly plan like Color Tile's. But there's a lot more rot in this barrel than anyone knows. Doctors and dentists, for example, may use a 401(k) to buy the building they practice in. That's fine for a well-to-do doc who also has other investments. But it's contemptuous of the nurse whose small savings are now tied up in one piece of real estate. Rick Shoff, president of NRP Financial Group in Jamison, Pa., and a recordkeeper for 401(k)s, advises employer-directed plans to put one or two employees on the investment committee. They deserve a say in where their money goes.

If I were czar, I'd stop plans from investing more than 10 percent of their assets in any real-estate or nonpublic business venture. These deals are illiquid and their value uncertain, says Norman Stein, professor of law at the University of Alabama. When you get a payout from such a plan, you may or may not receive a fair share, depending on how accurate the appraisal was. On rare occasions, you can't even get your share in cash. The plan might hand you a piece of paper attesting that part of the property is yours -- and a fat lot of good that will do you if you want to sell.

Require a warning label on plans that let workers invest in company shares. The shares themselves may be low-risk, but it's high-risk to overinvest in them. In general, you should put no more than 10 percent of your money there, even when business is good. If employers use stock to match employee contributions, the employees should be free to swap into something else.

Offer an investment alternative to employees who hate their 401(k)s. You'd lose your company match, but who cares, if it's buying the equivalent of Carter Hawley shares? At present, you can switch to a tax-deferred Individual Retirement Account, but only if (1) no funds went toward 401(k)s this year, for you or your spouse, and (2) neither has a traditional pension plan. Employees with modest incomes can take an IRA write-off even if they're in a plan. But that's worth only $2,000 a year. Why not pressure plans to improve by creating real competition? Let unhappy workers put the same dollars into some sort of independent 401(k).

Under current law, those responsible for a 401(k) are supposed to act prudently and invest for the good solely of the participants. "'But noncompliance is an option for small employers,'' says attorney Michael Gordon of Washington, D.C. "'Nobody thinks the government's going to knock on their door and enforce the law.''

Skunks like that might not pay attention to reform (complain to the Labor Department at 202-219-8776). But new laws could save the many plans whose sponsors aren't devious, just dumb.