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The Next Threat to Your Nest Egg

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Workers have seen the value of their retirement accounts slashed in recent months. Yet the latest news on the labor front calls into question the entire viability of the employer-sponsored retirement plan system.

Increasingly, employers are economizing by cutting back on their matching contributions to their 401(k) plans. Among the companies recently making cuts are General Motors (NYSE: GM  ) , Dollar Thrifty Auto Group, and Lee Enterprises -- all of which cited the cost savings coming from the measure as a motivating factor.

This isn't the first time that companies have used matching-contribution cutbacks as a cost-saving measure. Back in 2003, Charles Schwab (Nasdaq: SCHW  ) suspended its matches -- a somewhat ironic move, given that the company itself benefits from administering 401(k) plans for employers.

However, considering the extraordinary pressures the weak economy is putting on corporate America, there's greater fear this time around -- fear that the cuts may be permanent, and that this once-valuable employee benefit may be disappearing for good.

End of an era
If companies stop making matching 401(k) contributions, it would mark the end of the last token effort businesses make to help provide for employees, not just during the time they're employed but also after they retire. Already, 401(k) plans take most of that responsibility away from employers.

Traditionally, pension plans required businesses to make sure they saved enough and got good enough investment returns to fulfill monthly payment obligations for the remainder of their retired employees' lives. If the stock market didn't live up to expectations, it was up to companies to figure out how to cover the shortfall.

But a few years ago, many employers, such as IBM (NYSE: IBM  ) , Verizon (NYSE: VZ  ) , and Motorola (NYSE: MOT  ) , started freezing pensions in favor of defined contribution plans, in which much of the burden of saving for retirement instead fell squarely onto their employees' shoulders. Workers had to figure out how much to save and how to use the often limited investment options to their best advantage. If things didn't work out, well, that was tough luck for employees -- but beyond kicking in a few percent for a match, employers could avoid the substantial financial risk of managing a long-term pension plan investment portfolio.

What to do
If your company plans to stop making matching contributions to your 401(k), it essentially puts your employer-sponsored plan on a par with IRA options you already have. The sole benefit is in the much higher contribution limits for a 401(k) -- $15,500 this year, rising to $16,500 for 2009.

Before you give up on making 401(k) contributions, however, consider these specific factors:

  • What's the tax deduction worth to you? With 401(k)s, workers get an easy way to shelter fairly large amounts of income from current tax. That's incredibly valuable, especially if you're in a high tax bracket. If your tax burden is fairly low, however, you might prefer simply to make long-term investments in a regular taxable account. You'll give up a tax deferral, but you retain more flexibility to use your money for any need you encounter throughout your lifetime.
  • What investments will you make? If you own individual stocks or stock mutual funds in a 401(k), you give up some of the tax benefits that shareholders get in taxable accounts. One is the 15% maximum rate on capital gains and dividend income. The calculations can get complicated, but stock investors who intend to buy and hold stocks for extremely long periods of time may end up better off holding their shares in a taxable account -- especially shares with little or no current income payouts, such as Apple (Nasdaq: AAPL  ) and Rambus (Nasdaq: RMBS  ) . That's as long as those preferential rates continue into the future.
  • What fees will you pay? Many have criticized 401(k) plans for their high costs. If your only options involve high fees, you may be better off finding low-cost alternatives. Even held outside a tax-favored plan, the lower costs could more than offset the loss of tax benefits.

It's unfortunate that companies see cutting back on retirement contributions as a viable option to keep a productive workforce. Unfortunately, though, the current tough times are forcing employers to make hard choices -- and employees facing possible layoffs aren't in the best bargaining position to argue. Make the best of a bad lot and take responsibility for doing your own retirement saving -- whether you use your 401(k) or not.

For more on dealing with the challenges of retirement, read about:

If you're having trouble sorting through all of the choices you have to save for retirement, let us give you a hand. Our Motley Fool Rule Your Retirement newsletter service gives you tips you can use to create an investing plan, make better investments, and make the most of your money after you retire. Take a free look with a 30-day trial and see how Rule Your Retirement can calm your fears.

Fool contributor Dan Caplinger isn't giving up on his retirement. He doesn't own shares of the companies mentioned. Charles Schwab and Apple are Motley Fool Stock Advisor selections. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy won't give up on you.


Read/Post Comments (7) | Recommend This Article (26)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 19, 2008, at 2:11 PM, nerd51 wrote:

    I believe that the income tax rates are at a historically low levels. Given the huge Federal debt they have no where to go but up. That coupled with the limited choices of investment vehicles available with most 401K plans has convinced me that the traditional 401K is not a good deal for me.

    Some employers now have a Roth style 401K plan. In these plans, you contribute after-tax dollars but any gains are tax free once you reach retirement age. This kind of plan may be a good option if the funds offered under the plan have decent returns and low fees.

    Alas, my 401K plan doesn't even offer a single index fund.

  • Report this Comment On November 19, 2008, at 4:54 PM, GoNuke wrote:

    I think that people must come to understand that most only generate income for 60% of their adult lives. That is assuming one's parents have supported him/her as a child and that a person does not enter the work force until after college. 45 years in the workforce has to pay for 70 years of life as well as 20 years of an offsprings life and probably university tuition. People need to recognize that they cannot spend all their current earnings -regardless of how they are accumulated.

  • Report this Comment On November 19, 2008, at 7:38 PM, pianofritz50 wrote:

    And even MORE than a few years ago, (in 1985) Hewlett Packard went to a defined contribution plan... "at the bleeding edge of technology".

  • Report this Comment On November 20, 2008, at 11:21 AM, FinancialFellow wrote:

    I'm a little torn on this one. On one hand I think it is important for employers to offer some amount of matching 401k contributions because it encourages workers who otherwise may not contribute toward their retirement accounts to do so. Then again, matching contributions are a benefit and corporations should be more than free to reduce or eliminate them as they see fit. As long as company's continue to offer 401k's I think I am fine with them reducing or eliminating matching contributions. IRA's are great but the contribution limits are much higher on 401k's. Take away that investment vehicle altogether (not that this is presently being considered) and you are really going to hurt employees. If you are choosing to begin contributing to an IRA here's a good article providing some insight on which type makes sense: a Roth IRA or a Traditional IRA: http://financialfellow.com/2008/11/14/should-you-contribute-...

  • Report this Comment On November 20, 2008, at 11:34 AM, HeyPacketMan wrote:

    Employers that cut back on incentives for 401Ks will impair the ability of higher paid management employees to participate at all. The IRS top heavy audit rules allow higher paid employees to participate only if there is adequate participation by lower paid employees.

    GM is a mess. Funny how we don't see the same problems in the non-Detroit sector of the American Automobile manufacturing industry. The media never seems to notice how well US workers at Toyota, Nissan, BMW, Hyundai, etc are doing. Wanna bet they get 401K matches?

  • Report this Comment On November 23, 2008, at 3:36 PM, journeywithme wrote:

    401Ks are very important to employees. They provide a way for them to save for retirement and supplement the small retirement income from Social Security or any other source they may have. The matching contribution from the employer is an added incentive and, I believe, an additional way to compensate employees. Its a shame that 401Ks are being reduced or eliminated all together. But, on the flip side, this should force employees to take a more active role in planning for retirement by "shopping" for the best investment vehicles that will fit their retirement needs and not just solely rely on what the employer offers. In the long run.... employees will be better educated on this important aspect of finance and, may do as well, or even better financially.

    Be well.

    http://ourstockmarketjourney.blogspot.com/

  • Report this Comment On November 23, 2008, at 6:49 PM, crawlfish wrote:

    The 401K is a train wreck. People are not accumulating the monies needed for a conformable retirement. The problem is the 401K vehicle not people. Eventually a bunch of old people are going to show up at the governments door destitute and with their hands out. I am thankful that I have a government pension coming at retirement. But most people are not that fortunate . Right now from what I am reading some Representatives in the House of Representatives are looking at helping people by allowing them to convert their 401Ks to a form of government pension. This will allow the risk of outliving your money to be spread around with others just like with pensions and have the moneys professionally handled as well. That means that a lot less money needs to be saved for retirement . I hear companies rail against government involvement but then they do stuff like 401Ks that will call for government involvement sooner or later. Does the financial bail out come to mind. I have read the hype against this then a good article explaining it. While I hate the government getting more involved in ours lives this would be better than a bunch of old people starving to death. Before any one goes nuts on this idea it would be good to find out what this study is really about first. It is actually when facing the present reality the most promising solution proposed to date for old age security.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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