Federal Express, Sears, UPS, Eastman Kodak, Hewlett-Packard. The list of major employers that have halted their 401(k) match continues to grow as corporate profits hit the skids, forcing thousands of retirement savers to fend for themselves — at least until the economy recovers.
In many ways, they’re the lucky ones. A growing number of U.S. workers at small- to midsized firms, which suffer the effects of a downturn more severely, have watched their defined contribution plans terminate altogether as their employers go belly up or get bought out.
It seems that every day companies are retreating from their 401(k) commitments. More than 120 companies have announced a suspension of their match within the past nine months, according to the Pension Rights Center.
“Since the fall, a whole slew of corporations have suspended their 401(k) match,” says Dan Muldoon, research associate for the Center for Retirement Research at Boston College. “We experienced the same situation during the last recession between 2000 and 2002. It’s a way to trim the budget without having to lay people off, so it’s seen as a lesser of two evils.”
- The impact is huge.
- Create multilayer savings plans.
- Know your options when a plan terminates.
- Save smarter.
Most of the companies that instituted a 401(k) freeze say they plan to resume their match when their bottom lines improve.
But those affected — including some 18,000 employees who work for Salt Lake City-based health system Intermountain Healthcare — are facing tough decisions over where to direct new contributions and how to keep their long-term savings plans on track.
The impact is huge
“It’s hard to immediately process the effect of (a 401(k) freeze) when it happens in the present, but over 10, 20 or 30 years it can really have a big impact,” Muldoon says.
Indeed, the loss of employer contributions to a 401(k) has far greater implications on one’s nest egg than most retirement savers think, says Muldoon.
For example, if your employer matched 50 percent of your contributions up to 6 percent of your salary — the most common scenario — and you earn $75,000, that’s $2,250 in lost savings this year.
But the opportunity cost is what really stings.
Assuming a 7.2 percent average annual rate of return, that $2,250 yearly contribution would grow to $100,000 over the next 20 years through the magic of compounded growth. A five-year suspension would reduce that savings by 40 percent.
With a little financial planning, however, a loss of employer contributions to your 401(k) need not derail your retirement plan. In fact, it can be a good opportunity to establish new savings habits today that will provide for a more comfortable retirement down the road.
Create multilayer savings plans
If you work for a company that halted its employer match, but your 401(k) plan still stands, you should continue to fund your 401(k) plan as you had in the past, says Phil Cook, a Certified Financial Planner with Mogul Wealth Management in Torrance, Calif.
You should also ramp up your personal savings to make up for the missing match, but don’t necessarily funnel all those dollars into your retirement account.
“I would not be overly aggressive in funding my retirement plan,” says Cook. “Once you lock up money into a retirement account it’s very expensive to take it out again because you’ll owe taxes and penalties if you’re under age 59½. Even when you reach retirement age, you’ll still owe income tax on those contributions and, depending on your tax bracket, that can be expensive.”
His advice? Direct new savings first into an emergency fund.
In today’s economy, where layoffs are rampant and your employer has signaled financial vulnerability, every household should have three to six months’ worth of living expenses set aside in a liquid, interest-bearing account such as a money market fund.
“You want to be sure you’ve got some kind of cash reserves on hand,” Cook says. “You certainly don’t want to sacrifice an emergency fund to fully contribute to your 401(k).”
- Continue contributing to your 401(k) plan.
- Direct money into an emergency fund.
- Establish an investment portfolio.
- Open IRA after maxing out 401(k).
If you haven’t done so already, he adds, now is also the time to establish an investment portfolio that is unrelated to your nest egg.
“Everyone needs semi-liquid assets, like stocks, mutual funds or gold coins,” says Cook. “That way, if you lose your job, you can survive for the first six months on your emergency fund, and then start to liquidate your personal investments.”
How much is enough? There’s no magic number.
“Just start setting aside $200 a month for your investment portfolio,” Cook says. “It’ll take a while before it amounts to significant dollars, but you need to make your individual portfolio a priority.”
Once your emergency fund is established and you’re comfortable with the amount being directed toward personal investments, it’s time to step up savings to your tax-favored retirement fund.
If you’re not yet maxing out your 401(k), start there rather than opening an IRA, says Jack VanDerhei, research director for the Employee Benefit Research Institute in Washington, D.C.
“For many 401(k) participants, it would probably be better if they were looking at 10 to 20 investment options that the fiduciary has provided for them as opposed to being in an IRA and having literally thousands of different choices,” he says. “I don’t think most 401(k) participants would do sufficient due diligence in looking for what would be a correct investment alternative.”
But if you’re a self-directed investor, go ahead and open an IRA.
Deciding whether to open a traditional IRA or a Roth IRA is tricky. A traditional IRA offers an immediate tax deduction (within limits), but you’ll have to pay taxes at ordinary rates when you take distributions at retirement. A Roth IRA is funded with after-tax contributions, but you can take funds out tax free at retirement.
For the 2009 tax year, if you have access to a retirement plan at work and earn more than $65,000 a year — $109,000 for married couples filing jointly — you can’t deduct any contributions to a traditional IRA. The deductibility of these contributions begins to phase out at $55,000 for individuals; $89,000 for couples. (The income restrictions are relaxed when only one spouse is covered under a company retirement plan.)
Income limits also apply to Roth IRA investors. If your income is greater than $176,000 for married couples filing jointly ($120,000 for single filers), you can’t contribute to a Roth IRA, whether or not you have access to a company plan.
Know your options when a plan terminates
If your employer pulls the plug on its 401(k) plan for whatever reason, be it bankruptcy, merger or acquisition, the first and most important thing to remember is that your nest egg is not at risk. Any pre-tax contributions you make to a 401(k), plus your earnings, are yours to keep.
The matching contributions your employer made on your behalf, however, may or may not belong to you.
That’s because many companies operate on a vesting schedule, which requires their employees to work for a fixed number of years to accrue ownership of the employer-contributed benefits without having to forfeit them if they leave their job.
While many employers offer immediate vesting for matching contributions, others offer cliff vesting (all or nothing) under a two- or three-year schedule, or graduated vesting on a three, four, five or six-year schedule.
A five-year graduated vesting plan is common, giving employees a 20 percent stake in their 401(k) match each year for five years until they are fully vested and entitled to 100 percent of those contributions.
Your employer will offer you several options when it closes its plan. You may be able to roll the account into a new 401(k) plan run by an acquiring company, roll the money into an individual retirement account through a direct trustee-to-trustee transfer, or take a taxable distribution.
Avoid taking the distribution if at all possible. You will owe taxes on the earnings, plus a 10 percent penalty if you’re under age 59½. (The IRS may waive that penalty under certain conditions if you are “separated” from your job after age 55.)
When your employer pulls the plug on its 401(k) or puts a freeze on your match, it can deal your nest egg an unexpected blow.
But it’s also a prime opportunity to get your financial house in order, insulate your investments and establish smart saving habits today.
“It motivates you to revisit your financial goals in light of the new circumstances and realize that you may have to put more money into your accounts to reach them,” says Cook. “It’s like a financial checkup, which you should be doing on a regular basis anyway.”
The best part is, when the economy recovers and your company restores its contribution match, you’ll be used to living with less and, as such, be well-positioned to feather your nest egg even faster.