Your employer has just instituted a 401(k) program, and you're thinking about signing up. Join the club -- such salary-deduction retirement plans have been hot ever since they were introduced a decade ago.
But think again. Without careful tending, you could jeopardize your savings -- and your retirement.
In a 401(k) plan, you authorize your employer to deduct money from your paycheck and to deposit it into a fund or funds that you've selected.
Typically, your employer offers a range of investment options, from money-market securities to guaranteed investment contracts to growth stocks and bonds. Often, your employer will match, in whole or in part, the contributions you make.
For employees, the main benefit is tax-deductible savings. You can deduct the entire amount that you've put away in the 401(k) plan from your taxes -- a luxury not always afforded you with an individual retirement account. Moreover, whatever you earn on your 401(k) investments is tax-deferred; you won't have to pay taxes on it until you retire, when you'll probably be in a lower tax bracket.
"This is really the most effective long-term way of saving that you can find," said Betsy Burgett, a consultant at Towers Perrin, a New York-based management consulting and actuarial firm.
Still, 401(k) plans need careful tending.
The most important issue is knowing where your money is going. Many employees don't bother to read about what types of funds their money is being invested in, as they would if they were making the investment on their own. Instead, they choose from the selections presented to them and trust that their money is being handled wisely.
That's a mistake, as about 300,000 employees whose 401(k) cash was invested in Executive Life Insurance Co.'s GICs now know. Shortly after California and New York insurance regulators seized the financially troubled insurance company last spring, they indefinitely blocked these employees, who work for about 40 companies nationwide, from withdrawing their money from the 401(k) plans.
It's not yet clear when the workers -- many of whom probably had no idea that their money was invested in Executive Life -- will get their money back.
To avoid such a situation, research the funds before you put your money into them.
Talk to your human resources department to learn the identity of the plan's investment manager, what his investment policy is and what types of companies he invests in.
You can also obtain much of this information by looking at Form 5500, the plan's annual report. From Line 28 of the form, you'll be able to tell whether any of the plan's investment managers have left, a possible sign of weak performance. Schedule C of Part III will give you the reason for the departure.
If you're investing in a GIC, it probably will be through an insurance company that's guaranteeing the rate. Ask your employer which company it is, how stable it is and what types of insurance you've got if the company goes bankrupt.
Also ask about the latest A. M. Best or Standard & Poor's safety ratings for the insurance company. If the ratings aren't high, stay away from the investment, Ms. Burgett said. Check the ratings quarterly to make sure they remain high.
"If you were going out yourself and picking out a mutual fund to invest in, you'd do a lot of research," Ms. Burgett said. "It's the same for this. As an investor, you should know where your money's going."
This type of research will become easier once the Securities and Exchange Commission brings out a plan requiring employers to furnish prospectuses or quarterly reports that list the securities in their funds -- a policy change that could go into effect in the next several months. Still, most employers will provide workers with that kind of information if asked, Ms. Burgett said.
Another common mistake is the tendency to put all of your money in seemingly "safe" investments, such as GICs or money-market funds. An estimated 65 percent of all 401(k) funds are invested in such fixed-income funds, said Donald Metzger, assistant vice president for retirement plans at Baltimore-based Legg Mason Wood Walker Inc.
Even without financial trouble, these investments probably won't provide enough money for your retirement needs, many experts say. It's better to diversify, putting some money in a balanced stock fund.
The stock market may seem volatile and risky, but in the long run it probably will provide you with a much more comfortable retirement. After a 30-year career, the employee who has invested his money in a balanced equity account returning 10.5 percent annually will have 35 percent more retirement money than the worker who invested everything in a GIC returning 9 percent annually. That additional cash can make a big difference, because inflation constantly eats away at earnings and people are living longer and longer.
Even employees in their 50s should invest about 40 percent of 401(k) savings in a growth vehicle, Mr. Metzger said. "The biggest problem is that people are being too safe, and they risk outliving their dollars," he said.
"We often think about risk in terms of the volatility of the stock market, but we don't think in terms of accumulation risk -- the chances that over your career you will not have accumulated enough money to retire at the time you want to," said Richard Knapp, a consultant with A. Foster Higgins & Co. Inc., a New York-based benefits consulting firm. "That's something that needs to be taken into account."
Alyssa Gabbay is a free-lance writer who often covers business issues for The Sun.