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401(k) Take Charge of Your FutureA Unique and Comprehensive Guide to Getting the Most Out of Your Retirement Plans
By Eric Schurenberg
Warner BooksCopyright © 2003 Eric Schurenberg
All right reserved.
IntroductionMost of us aren't accustomed to thinking of the U. S. Internal Revenue Code as a force for good. That's partly because our political process assures that the tax code at any particular moment has less to do with sound policy than with which lobbies currently have Congress's ear. It's also because of the tax code itself-all 4,000 pages and 5.6 million words of it. It is so horrifically complex that not even experts can foresee all the ripple effects of any new tax provision. Even so, out of this sea of code sections and letter rulings, corollaries and subparagraphs, occasionally something washes up that is of genuine benefit to America and her citizens.
One of those pearls is the 401(k) savings plan. For millions of Americans, including me, it is arguably the sturdiest lifeline to a future of financial security. To employees who approach their 401(k) with the proper blend of discipline, patience, and basic investing know-how, it offers a reliable way to build a nest egg worth hundreds of thousands of dollars-or considerably more. No other investment even comes close. And for our savings-starved economy, the 401(k) is a godsend. As of 1997 the plans had already invested 675 billion dollars of employee savings that might otherwise have been consumed. Without that kind of savings push, the nation will inevitably see its standard of living decline.
Considering how indispensable 401(k) plans have become, it is amazing how accidentally they came into being. Unlike Individual Retirement Accounts, say, which have vocal supporters in Washington, no congressman ever campaigned for the creation of 401(k) plans. No think tank ever dreamed them up. Instead, Internal Revenue Code Section 401(k)-the brief passage that spawned the plans-was quietly slipped into the code by the Revenue Act of 1978, mainly to clear up a dispute over the taxation of profit sharing plans. The section says, basically, that an employee savings plan can include a cash or deferred arrangement as long as the plan is designed to benefit low-paid as well as high-paid employees, among a few other requirements. Cash or deferred arrangements (CODAs, in employee benefits jargon) were deals in which employees had the choice of taking their profit-sharing bonuses in cash (and owing taxes on them that year) or putting them into their savings plans and postponing their tax bill.
It took a quiet, religious, 38-year-old pension consultant named R. Theodore Benna to see the promise buried in Section 401(k)'s technical details. Benna had two key insights: first, he recognized that nothing in the law forbade an employer from applying CODAs to regular salary rather than just bonuses. He also saw that companies could chip in extra money to the plan to encourage employees to save, thus helping to ensure that the plan would serve all employees. While Benna's inspiration complied with the letter of the law, it was so novel that no one could be sure it would win the approval of the Internal Revenue Service. As a test case, his company, Johnson Companies, set up a savings plan modeled on his idea. In November 1981 the IRS finally gave the design the green light.
Benna could not possibly have anticipated how his brainchild would flourish. According to estimates by Access Research, Inc., more than 26 million employees at some 210,000 companies are now eligible to participate in 401(k) plans. Three-quarters of those workers actually do take advantage of the opportunity, and many of them have already racked up impressive savings. The average active employee in a plan has more than $32,000 in his or her account. Nearly 20% of them have more than $50,000.
The projected growth of the plans is equally astonishing. By the end of the century, the amount of money invested in 401(k)s is expected to exceed a trillion dollars. Within 10 years the money stored in 401(k)s will be corporate employees' single largest source of wealth-exceeding not only the value of their other retirement plans, but also the equity in their homes.
Obviously, 401(k) plans could not have achieved such widespread acceptance had they not fitted conveniently into several themes sweeping corporate America. Most important, perhaps, is the reengineering of the U.S. corporation. To a cost-conscious corporate treasurer, 401(k)s are the perfect retirement benefit. Compared to traditional pensions, they are less expensive to administer (about $89 per employee in a small company, compared with as much as $500 for a pension) and easier for employees to understand and appreciate (which means the employer generates more goodwill for the buck with a 401(k)). Perhaps most important, 401 (k)s absolve the employer of any responsibility to make sure that you take any specific amount of money with you when you retire. In a 401(k) plan, it's up to you-and you alone-to make sure you have enough money when you leave.
For employees, this aspect of 401(k)s requires a radical change in thinking. With a 401(k), the payoff you get from your company retirement plan depends first of all on you. If you don't take the initiative to contribute to the plan, it will do nothing for you at al1. Unless you learn to invest it wisely, it will never live up to its potential. These are not small matters. As you can see from the chart on page xvi, postponing your first investment from age 25 to age 40 will shrink your returns by more than half. And if you think you can ignore the realities of investing your plan, look at the chart on page xvii. Choosing investments that under perform by as little as one percentage point a year can shrivel your nest egg by more than $150,000 over the course of your career. Make no mistake: Decisions you make (or avoid) today regarding your 401(k) have real consequences.
That's where this book comes in. It's included to help you make the right decisions regarding your 401(k) at every point in the process-from enrollment and your first investment choices through finally withdrawing your money. While many employers make an effort to help their employees understand their plans, the educational materials they provide are often hopelessly superficial and vague. That's partly because companies have agendas they don't disclose to employees. For example, all companies worry tremendously about being sued if employees see them as giving advice that doesn't work out. Some companies want you to invest your 401(k) in the company's own stock, even if that's a bad idea (as it usually is). Whatever this book's shortcomings, pulled punches and hidden agendas won't be among them. As an objective guide unaffiliated with any 401(k) sponsor, this book's only agenda is to help you make the most of your 401(k).
The good news is, making the most of your 401(k) is not as difficult a task as you may think. Even if you're a complete novice at investing, you can master your 401(k) and take charge of your future. While some of the investing concepts you will encounter in the chapters ahead may be unfan1iliar, they are not mysterious. The principles behind them obey all the laws of common sense. The fact is, you don't have to be a Wall Street wizard to earn a respectable return from your 401(k). All you need is a firm grasp of the basic investing principles outlined in this book and the combination of gumption and patience to abide by them.
Excerpted from 401(k) Take Charge of Your Future by Eric Schurenberg Copyright © 2003 by Eric Schurenberg. Excerpted by permission.
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