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Is Your 401(k) a Ponzi Scheme?

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With so many people seeing much of their savings disappear, calls for reform throughout the financial industry have found renewed vigor. And after the revelation of the Bernie Madoff scandal, investors increasingly see Ponzi schemes lurking behind every corner, trying to draw unsuspecting innocents into their web.

Yet while 401(k) plans definitely have their flaws, the idea that they're a complete ripoff for investors is a huge exaggeration. Used correctly, your 401(k) can still be one of the most useful tools in your retirement savings arsenal to help you accumulate enough wealth to retire well.

Suffering huge losses
Obviously, many workers have seen their 401(k) balances shrink substantially over the past year. From estimates made by the Employee Benefits Research Institute, typical workers with at least 10 years of job tenure have seen losses of between 20% and 30% in their account balances since the beginning of 2008 through the end of January 2009.

Moreover, given that those estimates are more than a month old, you might have suffered even more pain from your plan account since late January. So, are 401(k)s really just a tool developed to ruin your retirement?

A conspiracy?
It's easy to create a reasonable-sounding conspiracy theory behind 401(k) plans. Back before 401(k) plans existed, many companies offered traditional pension plans to workers that would pay a certain monthly benefit for the rest of their lives after they retired. Workers didn't have to do anything to get that benefit -- rather, it was all up to employers to figure out how to invest so that they'd have enough money to pay their workers' retirement benefits.

Now, though, traditional pensions are becoming a thing of the past. Huge pension liabilities are part of the problem faced by long-time American institutions like General Motors (NYSE: GM  ) and Ford (NYSE: F  ) . Several years ago, large companies like Hewlett-Packard (NYSE: HPQ  ) and IBM (NYSE: IBM  ) started freezing their traditional pension programs and encouraging 401(k) participation in their place.

More recently, though, companies have started looking at their 401(k) programs as places where they can cut costs. Many struggling employers, including Motorola (NYSE: MOT  ) and UPS (NYSE: UPS  ) , have suspended or discontinued making matching contributions to 401(k) plans. With corporate profits down, the profit-sharing contributions that some employees enjoy might be the next thing to disappear. And while some employers insist that these cutbacks will be temporary, workers need to prepare to take sole responsibility for using their retirement accounts to greatest effect.

Why it's not a Ponzi scheme
Regardless of whether you believe the policy behind 401(k) plans is flawed and has merely served to help employers get the monkey of paying employee benefits off their back, you can't blame investment losses in your 401(k) account on a grand conspiracy.

In fact, you may end up better off than some with traditional pensions. Employers haven't had much better luck with their investments than workers, as companies like Northrup Grumman (NYSE: NOC  ) have faced massive pension shortfalls. Meanwhile, the government agency that backs up employer pensions, the Pension Benefit Guaranty Corporation, already faces a huge deficit and could see additional losses. Although the government will likely ensure that pension recipients are made whole, it could just add to the trillions spent bailing out the economy thus far.

Meanwhile, your 401(k) remains a huge and completely legal tax shelter opportunity, letting you defer tax on as much as $22,000 in 2009 if you're 50 or older. That could add up to tax savings of $7,700 for those in the highest tax bracket -- an amount you'd be hard-pressed to match with other tax-cutting techniques.

For more on protecting your retirement, read about:

If you need tips on how to make the most of your 401(k), you're not alone. Many subscribers to our Rule Your Retirement newsletter service started out with 401(k) questions and concerns just like yours and have found the answers they needed. Learn from our experts as well as people just like you by trying out Rule Your Retirement free of charge for 30 days.

Fool contributor Dan Caplinger has maxed out his 401(k) every chance he's gotten. He doesn't own shares of the companies mentioned in this article. UPS is a Motley Fool Income Investor pick. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy has enough information to give to everyone.

Read/Post Comments (9) | Recommend This Article (10)

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 February 23, 2009, at 3:43 PM, boxesforsnobs wrote:

    The title to this article is the worst sort of sensationalism. What new low will you stoop to in your next article to get already terrified investors to click on your link? for shame...

  • Report this Comment On February 23, 2009, at 4:44 PM, TimothyVR wrote:

    I agree with the above post: a terrible title for a reasonable article.

    As for the 20-30% drop: I have lost about 40%. Obviously I am doing something very wrong....

  • Report this Comment On February 23, 2009, at 6:36 PM, hetstreet wrote:

    "The good old days", when everybody got their gold watch and pension at retirement NEVER HAPPENED. Less than 1/3 of American workers ever received any form of retirement payout from their employer. And 3/4 of them were firefighters, police officers, manufacturing, and mining workers- people doing thankless, low wage jobs. They had (and many still have) a pension as a reward for doing a hard job (that most people wouldn't do) for a lot of years, for low pay.

    Now is the time when we have to be responsible for ourselves- and 401k fits that idea perfectly.

  • Report this Comment On February 24, 2009, at 11:45 AM, ackho wrote:

    And here I thought this article was going to be about how the likely utter destruction of the dollar over time makes 401k's effective vehicles for people to save and build wealth to only have it slept under the rug by government policy.

  • Report this Comment On February 24, 2009, at 12:11 PM, Slipswitch wrote:

    I have lost about 40% too, by following buy/hold recommendations at MF. I've learned what the smart MF subscribers knew all along. You need to buy and sell to take profits or cut losses. MF has a good ports, but you need to apply sound logic to them. Buy and hold may be good for people as smart as Buffet, but not most of us part-time investors.

  • Report this Comment On February 24, 2009, at 12:44 PM, sanfrancis wrote:

    I lost 40% - 50%. Pulled out last week. So when do I get a tax credit for the money that I lost? I didn't think so... You do the right thing and end up paying the consequences of thieves, while those who cheat and steal are seemingly walking away with the money. I am beginning to think that my grandfather was right- Bury your money in can.

  • Report this Comment On February 24, 2009, at 3:52 PM, Rasbold wrote:


    You will never recover now! You should be dumping money IN!! to offset the losses. It will return, and sooner than we all think.

    It is hard to watch you portfolio losing the battle, but you just lost the WAR.

    Let it ride, man, Let It Ride and your Dow will never Jones!

    BTW 401(K) are not ponzi's. Give me a break, and some Tax Shelters!

  • Report this Comment On February 24, 2009, at 7:34 PM, sanfrancis wrote:

    In any other world, I would agree with you Rasbold.

    When you have already lost 50% and it decreases every day, you will end up with 0%. It's hard to rebound at that point. Wouldn't you agree?

    'Dumping money IN' You must work for a bank, broker, or the government !

  • Report this Comment On February 28, 2013, at 10:05 PM, iPhoned wrote:

    Go out on a city street with a card table, some Play Money, and some game props.

    Tell passers by if they put 6% of their earnings on the table, a company will match it, with play money.

    Now that they've given a percent of their yearly income to you, tell them You are going to pick which game they are allowed to play, including which brand of dice, cards, shells, and table.

    Don't forget to gently mention you will be charging them a percent for the privilege of playing, and the IRS will be taking their chunk if they cash out early, or when they cash out in the end.

    Never mention the company never really gave another 6% of their salary to you, but you as the "broker" are giving the corp a float in the stocks you already pre-picked for the employee to choose from.

    Am I close?

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