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The Best Fix for the 401(k) Mess

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Nobody's happy with employer-sponsored retirement plans right now. Workers have lost huge portions of their savings in 401(k) plans. Policymakers want better options to help people save for retirement. But amid all the challenges that many workers face, one retirement plan already exists that could serve as a great model for anyone seeking 401(k) reform.

Unfortunately, you won't find that solution in the private sector. Employers have been cutting back on their contributions to 401(k) plans at an alarming rate, with companies such as FuelCell Energy (Nasdaq: FCEL  ) and Hurco (Nasdaq: HURC  ) joining hundreds of others that have scaled back or eliminated employer matching contributions.

But there's one plan where matching contributions haven't been threatened, and where it's impossible to criticize investment options for their high costs. The federal government's own Thrift Savings Plan (TSP) has a lot of positive attributes, and even if you can't take advantage of it yourself, it can at least stand as a model for other plans to emulate.

Get thrifty
The TSP is the retirement savings option given to federal employees, including members of the military and civilian government. Technically, it's not a 401(k) plan, but it acts a lot like one: The same 2009 contribution limits of $16,500 for those under 50, and $22,000 for those 50 and older, apply to both, and you get the same tax advantages that 401(k) plans offer to private-sector employees.

From the standpoint of how to invest your money, the TSP doesn't give you the largest number of investment choices. But the five options it does offer span a huge range of investments:

  • The G fund acts as a short-term, principal-protected investment option, but offers participants a return more similar to that of a long-term government bond. In essence, the fund resembles the stable-value options that some 401(k) plans provide, but without the risks involved.
  • The F fund is a fixed-income option that tracks a broad benchmark of government, mortgage-backed, and corporate bonds.
  • The C fund tracks shares of large-cap domestic stocks such as Goldman Sachs (NYSE: GS  ) , McDonald's (NYSE: MCD  ) , and other companies included in the S&P 500 index.
  • The S fund gives investors exposure to U.S. stocks outside the S&P 500, tracking what used to be called the Wilshire 4500 index. That index includes companies like Visa (NYSE: V  ) , Mosaic (NYSE: MOS  ) , and First Solar (Nasdaq: FSLR  ) that aren't in the S&P.
  • The I fund allows participants to make international investments. The fund tracks the popular MSCI EAFE index of developed foreign stock markets.

In addition, the TSP offers lifecycle funds that automatically allocate money among each of these options. All you need to do is pick an appropriate target retirement date that meets your needs, and the fund handles the rest.

Low fees and great features
Perhaps the best thing about the TSP is its low fees. Despite the fact that the plan operates without taxpayer support, investment costs were a ridiculously low 0.015% for the most recently reported 2007 plan year. The combination of index funds and using forfeited matching contributions to fund plan expenses allows the TSP to keep costs low.

Moreover, many federal employees are eligible for employer contributions. In addition to an automatic 1% contribution, employees can earn further contributions amounting to a maximum of 5%. Although military personnel don't generally earn a match, the capacity exists for certain specialized occupations to receive designations that make them eligible for matching.

Match the TSP
The TSP serves as a model that other employers should follow. The commitment to low fees, a small yet broad range of investment options, and responsibility to supplement employees' retirement savings are all positives that can lead to higher morale and financial security. If your employer does anything less for you, you should consider emulating some of the attributes of the TSP with your own money -- or lobby your company to do so, before people conclude that the 401(k) system is truly broken beyond repair.

For more on trying to salvage your retirement savings:

Fool contributor Dan Caplinger would love to be part of the TSP, but he'll settle for his own 401(k). He doesn't own shares of the companies mentioned in this article. Hurco is a Motley Fool Hidden Gems selection. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is the best we can make it.


Read/Post Comments (4) | Recommend This Article (7)

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 July 08, 2009, at 4:48 PM, lamontcg wrote:

    I don't understand how this differs in any way from my 401(k) with vanguard?

    I have the option of putting money into a money market fund (which may not be 'perfectly' safe, but vanguard's money market option is truly conservative, and the government isn't going to let money market funds collapse), and there are two bond funds which are up 4-5% annualized over the past 5 years, and obviously vanguard basically invented the no load, low cost index fund so I've got those option. In addition to that there is the usual choice of target retirement funds and more aggressive investments.

    The "problem" with 401(k)s is really asset allocation and unsophisticated investors being pushed to carry far more of a balance in stocks than they have a tolerance for dealing with the downturns in the market. The problem there is that wall street has sold them on stocks being a sure bet on a long enough time period. A lot of them are pulling out of their 401(k)s after having dollar-cost averaged and bought the highs of market in 2007 and now they're going to miss out on dollar-cost averaging through the lows and miss all the upside.

    Those people should be putting money into money markets and bond funds nearly exclusively -- and none of them were worried about the 401(k) "problem" when their investments were going up with >16% annualized returns during the 2003-2007 expansion.

  • Report this Comment On July 08, 2009, at 5:09 PM, 42theflush wrote:

    The array retirement programs is rigged. No more ABC 123 plans. I say all monies invested for retirement earn tax free appreciation. Period.

  • Report this Comment On July 08, 2009, at 6:26 PM, mythshakr wrote:

    Why is it so impossible just to let me move my contributions into my own brokerage account and manage it myself? Why is it I have to quit to have this rollover ability?

    Why is it that employer matches as low as 1% put employees within "qualified" plans that disqualify them from self directed plans that allow much higher tax deferred contributions?

    Is there truth to the rumor that the real reason congress passed the 401K type legislation in the first place is not to enable people to save for retirement but, as an incentive to people to give their money over to the financial services agents to make money off of?

    Why is that all of these "benefit" plans, retirement and healthcare, contain such poison pills to the detriment of the individual?

  • Report this Comment On July 09, 2009, at 8:17 PM, lamontcg wrote:

    "Why is it so impossible just to let me move my contributions into my own brokerage account and manage it myself? Why is it I have to quit to have this rollover ability?"

    Most people can't handle investing. They really need to stick to index funds and safe bond funds that earn sedate levels of return.

    I agree that I would like to be able to sign something that says I understand the risks and want to play outside the kiddie pool and want to blow my retirement on options contracts on gold mining stocks if i so choose. The bulk of the population, however, clearly needs to be steered towards more sedate bond-index-tracking choices and even away from stock index funds. Most people want something closer to a defined benefit or defined-rate-of-return and can't handle losing any principal in the stock market -- and some of them compound the problem by unloading at the bottom. Look at the ads for Charles Schwab on CNBC for good examples of the archetypes of unsophisticated investors who are losing their retirements in this market.

    And yes, there's clearly a benefit to the financial sector, both in management fees and in having really dumb money pumped into the markets every month buying the SP500 on autopilot.

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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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