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Make sure your 401(k) works in your best interest

JEFF BINGHAM • Feb 10, 2007 at 11:15 AM

A study by professors at New York University's Department of Finance found that for 62 percent of 401(k) plans, the types of choices offered are inadequate, and that over a 20-year period, this makes a difference in accumulated wealth of over 300 percent. Also, the funds included in the plans are riskier than the general population of funds in the same categories.

If you've been eagerly awaiting the Roth 401(k), more patience may be needed. According to benefits-consulting firm Hewitt Associates, just 13 percent of the 220 companies surveyed by the firm said they were very likely to offer the new Roth IRA-like retirement plan option in 2006.

That's just one of several findings of recent Hewitt studies that provide a status report on what has become the primary retirement savings vehicle for most employees. The news is mixed, with participation rates and average account balances growing to 70 percent and $69,000, respectively, but some counterproductive tendencies were found among savers. The survey results suggest dos and don'ts for improving your retirement outlook.

Don't neglect your plan. While the quickest way to derail an investment plan may be to trade frequently and chase hot stocks or funds, that's not the problem for most 401(k) investors. Rather, they're taking a normally commendable buy-and-hold mentality to extremes. According to Hewitt, only 17 percent of plan participants made any adjustments to existing investments in 2004. That can be a mistake if, say, stocks have a great year, gaining 25 percent, while bonds drop 10 percent. Suddenly, your 60/40 mix of stocks and bonds shifts to 67/33. If those trends continue for a few years, as they often do, you could end up with almost all your money in stocks just when bonds are poised to outperform equities.

Do take advantage of automatic plan options. Workers' hands-off tendencies are apparently stoking employers' worries.

In another Hewitt survey, just 6 percent of companies expressed confidence that employees will take accountability for their retirement future. Chief concerns are that employees will not sign up for a 401(k), will neglect to increase contributions, and will let the mix of investments get dangerously out of balance.

So now many employers are changing the way 401(k) plans are structured, requiring you to opt out, rather than in, for automatic enrollment, contribution hikes, and rebalancing. With other plans, you need to choose these helpful options, for example, signing up for a feature that increases contributions on a regular schedule, perhaps timed so that a percentage of an annual raise gets funneled to your 401(k).

Don't cash out. This is chiefly a problem among younger workers, so if you have adult kids, you may want to remind them of the benefits of long-term, tax-deferred compounding. According to a Hewitt survey of 200,000 retirement plan participants, almost half had opted to withdraw 401(k) account balances when leaving a job. Among employees aged 20 to 29, two-thirds took the cash, incurring income taxes and a 10 percent IRS early withdrawal penalty, rather than leaving the savings in place or rolling the money into a new employer's plan or an IRA. Even a small balance may compound into a sizable sum over several decades. For example, a 25-year-old's $10,000 account, left to earn a 6 percent return for 40 years, would grow to more than $100,000.

A major trend in pension plans offered by companies is a movement from defined benefit plans to defined contribution plans. The majority of defined contribution plans offered by companies are 401(k) plans. It is more important than ever to make sure your company is offering a plan that will give you the opportunity to have a comfortable retirement.

So, does your 401(k) need more care?

Jeff Bingham is president of Bingham & Hensley in Kingsport and a registered investment adviser offering securities through NFP Securities Inc. He can be reached at (423) 247-1152.

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