You know selling in a panic won't help your investments. But Congressional lawmakers didn't get the message -- and they're putting your savings strategy at risk.

After passing the $700 billion rescue package two weeks ago, some representatives have turned their eyes toward reforming Wall Street. Yet the target they've chosen is the foundation for retirement security for millions of workers: tax-favored 401(k) plans.

House leaders held hearings last week to discuss the possibility of getting rid of the tax deductions for contributions to 401(k) plans. Citing statistics that show high-income taxpayers get a disproportionate benefit from 401(k) deductions, as well as the recent steep declines in most workers' retirement-plan balances, leading politicians believe that alternatives could better serve the purpose of helping all workers have a secure retirement.

Forcing investors into bonds
One proposal, from New School economics professor Teresa Ghilarducci, recommends replacing 401(k) plans with government-managed retirement accounts. Under Ghilarducci's plan, workers would contribute 5% of their pay, and the government would add a fixed amount above that -- similar to matching contributions from employers now, although not necessarily as large.

The real difference between 401(k) plans and a government-managed alternative is in the way your money gets invested. Under the proposal, savers would be forced to invest in bonds similar to existing inflation-protected bonds, also known as TIPS, that would guarantee a return 3% above the inflation rate.

A convenient scapegoat
It's not surprising that legislators are upset with the problems in 401(k) plans now. With stocks under nearly constant attack and people seeing their life savings at risk, it's easy to blame the stock market for every economic problem we're facing now. Workers at companies such as Morgan Stanley (NYSE:MS), Citigroup (NYSE:C), and Ford Motor (NYSE:F) with company stock in their retirement plans have suffered huge losses. And with gargantuan outlays for government-sponsored initiatives to help preserve the financial system, the effective tax increase from eliminating 401(k) deductions looks like a rare opportunity to raise at least a little bit of revenue.

But the plan has several flaws. The most important one is that the government's plan won't give workers enough savings for them to retire. With inflation historically running at 3%, a 6% total return on retirement savings simply isn't enough for many workers to reach their financial goals. Consider: Someone with a $60,000 salary would save $3,000 under the plan. If the government adds $600 as a match, as Ghilarducci suggests, that comes to $300 per month. Over 40 years at 6%, $300 in monthly contributions would yield around $600,000.

That sounds like a lot. But the purchasing power of that $600,000 would have been reduced by nearly two-thirds in 40 years, making it worth less than $185,000 in current dollars. If you use a standard rule of thumb that allows you to withdraw 4% per year from your retirement savings -- a rule that might not work with an all-TIPS portfolio -- that means you'd get just a little more than $600 per month in current-dollar purchasing power from your portfolio. Combined with what Social Security will pay, that won't put you in the lap of luxury.

In contrast, even if you think returns on stocks will be lower in the future than the 10% they've averaged in the past, you'd still end up way ahead. With an 8% return and similar contributions, you'd end up with more than $1 million -- and when you combine the value of the tax deduction on top of company matches that are often 50% or more, you could finish with a lot more.

Moreover, over periods of 30 years and more, many stocks have put in better returns than 8%. Here are a few:


30-Year Average Annual Return

Wal-Mart (NYSE:WMT)


DuPont (NYSE:DD)


Coca-Cola (NYSE:KO)




Source: Yahoo! Finance.

You can do it
Perhaps most importantly, the message sent by eliminating 401(k) plans would be devastating: It would suggest that most people can't be trusted to invest their own money. As hard as it's been for workers to become independent from disappearing company pensions, the move from company-run pensions to 401(k)s has made all of us learn to be responsible for our own retirement. In my view, that's an empowerment that no one should try to take away.

In contrast, reversing that course by telling every single worker in the nation that the stock market is too risky for his or her retirement savings would be ridiculous -- and would deprive millions of any chance at a comfortable retirement. That's too high a price to pay. The financial panic has put a big dent in 401(k)s -- but getting rid of them entirely would be a huge, panic-driven decision by lawmakers, with dire consequences for the financial security of working America.

For more on the panic of 2008:

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Fool contributor Dan Caplinger's 401(k) balances are down, but he's not crying about it. He doesn't own shares of the companies mentioned in this article. Wal-Mart and Coca-Cola are Motley Fool Inside Value recommendations. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy won't panic on you.