Investing for retirement through a 401(k) plan was the topic of the June 25 conference sponsored by Business Week Online. The guests were Business Week's Jeffrey M. Laderman and John Meehan.
OnlineHost: Good evening and welcome! Business Week Online is happy to present its regular Sunday evening conference, tonight a discussion of retirement planning and 401(k) plans -- based on the cover package, The Smart 401(k), in the current issue of Business Week (July 3).
More and more companies are making 401(k) plans the cornerstone of saving for retirement, in place of conventional pension plans. Here to discuss 401(k) strategies and answer your questions are the two principal authors of the BW package, Associate Editor John Meehan and Senior Writer Jeffrey M. Laderman.
John Meehan (Jombw), who joined Business Week in 1989 as money and banking editor, has been corporate strategies editor since 1992. A graduate of City College of New York and the Columbia School of International Affairs, he is co-author of "House of Cards: Inside the Troubled Empire of American Express."
Jeff Laderman (JeffBW) covers the stock market and mutual funds. He is the author of "Business Week's Guide to Mutual Funds" and a graduate of Rutgers and the Columbia Graduate School of Journalism. The moderator is Jack Dierdorff (JackBW), consulting editor of BW Online.
JackBW: Good evening to you on AOL. And good evening, Jeff Laderman and John Meehan.
JeffBW: Hi, Jack, John.
Jombw: Hi, Jeff. Hi, Jack.
JackBW: I'll ask the first question. John, to get down to basics, what is a 401(k) plan? And how does it differ from the conventional corporate retirement plan?
Jombw: First, the 401(k) gets its name from the IRS code that created it 14 years ago. Unlike a traditional pension plan, the employee takes the lion's share when it comes to responsibility. The employee contributes most of the money and selects the investments.
JeffBW: Yes, the traditional plan is a defined benefit. The company decides what it will pay you, and decides how to invest that money to earn that pension payment.
JackBW: Dr Rodger in the audience asks this, John and Jeff.
Question: How can you convince your employer to offer a 401(k)? I work for an insurance company that employs more than 700 people, and they refuse to offer one. We currently have a defined-benefit plan that gives us 1.5% of the last five years' average salary per year.
JackBW: Who wants to tackle that?
JeffBW: I'll do it. You have to lobby your benefits department and perhaps get your fellow workers to join in. The cost of a 401(k) is not very much. You put in most of the money. Even if your company doesn't want to match your contributions, you can amass a lot of money on a tax-deferred basis.
JackBW: TumRumble has an investment-strategy question.
Question: Should you max out your 401(k) before ANY other investment?
JeffBW: A qualified yes. The advantage of 401(k) is its tax-deferral feature. But you also have to lock up the money for a long time. I would make sure I had some other money set aside that you could get to if you need it quickly. But a 401(k) should be your major long-term savings plan.
JackBW: Porsha94 has a related question.
Question: Hi, tell me is 25 years of age too young to start a 401(k) plan?
Jombw: No, not at all. The younger, the better.
JeffBW: We outline what a 27-year-old might do in our story. You can retire with $3 million or $4 million, if you start contributing now, make smart choices, and stick to it for 40 years.
JackBW: Lalisner asks this. John?
Question: What's the average employer matching rate?
Jombw: There is no average that we could really find. But many companies usually give 50 cents on the dollar up to some predetermined limit.
JackBW: PICKIN 6 has your name on this question, Jeff.
Question: Jeff, when considering growth, income, bond, and international vs. domestic mutual funds, what type of asset allocation would you recommend for someone anticipating retirement in 20 years?
JeffBW: Let me refer to the story. We have an example like that. We show 37% bonds, 23% large-company stocks, 20% small-company stocks, and 20% international stocks.
JackBW: Lalisner has another question, particularly apt for a younger person.
Question: What is the earliest age you can access 401(k) funds?
Jombw: Generally, you can borrow against your 401(k) funds at any time. You should pay back at a schedule your company has determined. For some companies, that is 20 years for a home loan. If you go beyond that time, the company will notify the government that you no longer qualify for the tax deferral.
JackBW: Try this question next.
Question: Are 401(k) plans as good as defined-benefit pension plans? How many of the latter still exist?
JeffBW: It depends on the particulars of each plan.
Jombw: There is a big debate among companies about which is better. By far, 401(k) plans are cheaper to operate, and there are fewer regulatory requirements. But keep in mind that some companies are very concerned that employees will retire with insufficient funds because they invested poorly. That opens up all new legal questions about the responsibility of employers
JackBW: JTCorrent wonders about juggling 401(k)s and IRAs.
Question: If your company offers a 401(k) plan and you are participating in it, can you still invest in an IRA and have it tax-deferred?
JeffBW: Generally no, unless your income is below a certain level -- I believe it's $40,000 for couples, but don't hold me to it. The deductible IRA is phased out by $50,000 or so.
JackBW: TumRumble has another question.
Question: Do companies generally manage funds, or do they hire outside companies? If outside, who are the most common companies?
JeffBW: Companies don't manage them. They hire professional money managers. In the 401(k) area, the biggest managers are mutual-fund companies like Fidelity, T. Rowe Price, and Vanguard
JackBW: PSAG's question raises one for me -- is any return at all guaranteed?
Question: Is it true that none of the 401(k) plans guarantee a return greater than 5%?
Jombw: There are no guarantees. It's like playing the market. It goes up and down.
JeffBW: That's why you have to be a smart investor with your 401(k) money.
Jombw: That is also why you have to invest with an eye on how many years you have till retirement.
JackBW: I want to go back to the question of access to your 401(k) money. Several people are asking similar questions about how you can dip into it or borrow against it. Can you summarize the rules?
Jombw: It depends on the company and what loan features it has. Until recently, many companies did not publicize loan features for fear that employees wouldn't pay back the loans. There are no concrete rules on borrowing -- it depends on what the company offers. But it is wise to check with your employer on their particular rules and also to find out at what point the tax deferral lapses. I am not sure about when it does.
JackBW: Jeff, do you have any general advice for LOCKSMTH?
Question: I have been looking at the different options, and tried to decipher out the confusion, but it's not easy. I had a Fidelity Cash Reserve account, and with my bosses' recommendations, I switched to Equity Income II. It seems to be doing well. What do you suggest?
JeffBW: We can't give specific advice, but if your money just sits in a cash reserve, it's never going to earn enough for your retirement. It will barely keep ahead of inflation. Fidelity Equity-Income II has a very good track record. It's a moderately conservative fund. But if you are 30 or so, I'd go for a more aggressive fund.
JackBW: BobA has heard warnings about dipping into funds such as 401(k).
Question: On the question of dipping into your 401(k), I've always heard that borrowing against your pension is the worst mistake you can make. Right or wrong?
JeffBW: Generally, not a good idea.
Jombw: It depends.
JeffBW: If you spend it now, you won't have it later. But if it's an emergency, it's nice to know it's there. I wouldn't use it to buy a BMW or something like that.
JackBW: Jeff92868 wants to be sold on the virtues of a 401(k).
Question: I work for a small contract-engineering firm and will soon be eligible for the company 401(k). This company has just recently started a 401(k) for employees and is a small business -- fewer than 60 people. What advantage would my company 401(k) have over a bank?
JackBW: Tax-deferral, of course -- other advantages?
JeffBW: Lots of advantages. First, the money you put in is pretax. The investment earnings are tax-deferred.
Jombw: Matching contributions, also.
JeffBW: If you put money in a bank, you have to do it with aftertax dollars and pay tax on the interest.
JackBW: POOSH DK has the next question.
Question: Once someone is at the maximum contribution level for a 401(k), what would be an additional retirement saving vehicle?
JeffBW: Good question. Lots of people want to do more than their 401(k) allows. First, see if your 401(k) has an aftertax option. That works just like the regular 401(k) except you put in aftertax money. The investment earnings, though, are tax-deferred. Next, there's the IRA. You can still put in $2,000 a year even if you don't qualify for the deduction. You put in aftertax dollars, and the earnings are tax-deferred. Finally, there are variable annuities, which work sort of like tax-deferred mutual funds.
JackBW: John, I think this one's for you.
Question: What kind of legal problems might a company face in connection with an employee's use of a 401(k)?
Jombw: First, a company is legally responsible for providing sound investment choices. It also has to select capable money managers. If an employee finds that the company hasn't done either, he or she could sue. The other question has to do with the performance of the 40l(k). If a baby boomer ends up retiring in 15 years without enough money to live on, many companies fear that the employee can turn around and file suit, claiming that the company didn't provide sufficient education. And nobody knows what sufficient education is at this point. The Labor Dept. will issue guidelines on education in August.
JackBW: JCPerk's question bears on tax rules. Can we help?
Question: I am covered by a qualified retirement program from my employer. Is my wife able to make any deductible contribution to an IRA?
JeffBW: No, I tried that one myself, and she can't do it, though logic says she should be able to.
JackBW: DaVoice has this for you specifically, Jeff.
Question: JeffBW, when would you see a variable annuity as an appropriate investment for a 401(k)? They generally have higher loads and don't add the tax-deferral aspect that they would in a nonqualified plan.
JeffBW: They are not investments for a 401(k). Variable annuities are tax-deferred investments you may consider after you've maxed out your 401(k) and wish to do more.
JackBW: How about this one from Hawk 1963?
Question: My company matches 50 cents on the dollar up to 4%, and my wife's company does not match at all. Is it wise for her to invest in her own plan, or should I increase mine? I currently am investing 6% of my salary.
JeffBW: Your wife should contribute to hers. You won't get any more benefit switching that money to your 401(k) because you've already hit the maximum match.
JackBW: Dr Rodger has a follow-up question.
Question: Jeff, Earlier you indicated to put aftertax money in a 401(k), What advantage would this have, as opposed to investing in the same fund? You would be taxed on investments the fund sold, but not others, and not subject to the withdrawal or other penalties.
JeffBW: The aftertax 401(k) still defers income and capital gains. A regular mutual fund does not do that.
JackBW: KJ Sooner wants help with an employer.
Question: What can I do to get my company to increase the number of investment options (currently fixed-income, company stock, S&P 500 index fund, and Extended Market index fund)? I got no reply to a letter I sent.
JackBW: John?
Jombw: By law, a company has to offer at least three options of varying risk. This does not include company stock. It is up to the company to determine how many choices to offer. Some employees have been very successful in lobbying their employers for more choices. Many like to point out the higher performances of international or small-company funds. Companies are receptive. They feel the more they offer, the more they lower their liability.
JackBW: Another question of legalities, from Rochgwc.
Question: I am in a company that refuses 401(k)s to union-represented employees. Is that legal?
Jombw: Many companies offer 401(k)s to union members. Some unions have actually negotiated increased company matches in lieu of raises. However, a company that offers 401(k)s can legally withhold them from any group of employees, such as those belonging to a union.
JackBW: Jeff, here's a chance to mention the BW mutual fund book.
Question: Is there any specific books you would recommend someone to read, to give them a better idea of the types of funds available and what's possible for them to do, like for computers, maybe "Retirement Manual for Dummies"?
JeffBW: Yes, do I have a book for you! Business Week's Annual Guide to Mutual Funds. It's everything you need to know to be a savvy fund investor. You can download a sample chapter from the book in the download section of BW Online (Mutual Fund Corner or Business Bookshelf). The book is also available at bookstores and through BW Online.
JackBW: As we wind down, here's a question that might be from a gold bug.
Question: Isn't investing in gold or other precious metals more reliable than paper?
JeffBW: If you put $1 in gold in 1980, you would have about 50 cents now. The stock market is up nearly five times since then.
JackBW: One final question.
Question: Why is it that companies apparently have so much trouble persuading people in the middle and lower pay ranks to join 401(k) plans?
Jombw: It is a question of take-home pay. Many employees feel they can't afford it. It is also a question of education. Many people are bewildered by investment choices and programs that they don't really understand.
JackBW: But in the long run, it definitely pays off.
JackBW: That's it for tonight. Thanks to my colleagues, Jeff and John.
Jombw: Thank you, Jack.
JeffBW: Goodnight Jack, John.
OnlineHost: Thanks to John Meehan and Jeff Laderman of Business Week and all the BW Online team for this conference. And thanks to all of you on AOL -- with apologies to those whose questions we didn't have time for.
If you'd like to continue the discussion, we invite you to move to the BW Online Chat Room or post comments and questions on the BW Online Message Boards (try the Economics & Finance or Personal Business category). Transcripts of all BW Online conferences are available soon after the event (look under Talk, Special Events, or Search BW).
Join us here in BW Online on Thursday, June 29, for a conference on municipal bonds with Alexandra Lebenthal, president of securities dealer Lebenthal & Co. (9pm ET, Bowl). Plus, of course, every Sunday at 9pm ET, BW Online is here in the Globe. Thanks again and goodnight!
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