Depressed 401K Value Warrants Caution

In January of this year a survey conducted Fidelity Investments reported that the value of 401(k) retirement accounts plunged an average of 27 percent in 2008. In addition to heavy losses in the market, many employers have chosen to discontinue or reduce matching fund contributions in an effort to shore up working capital.

Despite these changes, however, Fidelity reported that most workers are continuing to invest in company-sponsored retirement plans. But what exactly is a 401(k) and how does it work?

Put simply, the Tax Reform Act passed in 1978 authorized the creation of a tax-deferred savings plan for employers under section 401, paragraph k - hence the nickname. Those who participate in the program have funds diverted to specially designed investment accounts before taxes are assessed, making it a doubly attractive savings opportunity.

A third party investor manages the money, investing in mutual funds, bonds, money market accounts and other growth vehicles. The account manager will assist the owner in determining the best options for diversification of the portfolio and the level of risk involved. Unlike a pension, a 401(k) plan is also secured against corporate catastrophe.

If your employer were to declare bankruptcy, or experience similar financial problems, The Employment Retirement Income Security Act (ERISA) of 1974 provides regulations to protect private investment income. The provisions require that all 401(k) deposits must be in custodial accounts to safeguard them in the event that the employer should go out of business.

Funds from a 401(k) plan can be cashed out at any time, but substantial tax penalties may apply. People changing employers also have the option to roll that money into a new 401(k) plan with their new employer without penalty.

A "pension plan," on the other hand, is generally held and financed by the employer and is unique to that company. The money is paid to the employee upon retirement and cannot be taken out prior to a specified age. Pension plans often lack the legal protections provided by law for 401 (k) accounts.

As investment values continue to roller coaster, however, individuals who may be losing a job need to be careful about planning ahead if they have a 401(k) plan. Knowing how to handle these accounts can be critical to long-term financial health.

"People who are changing jobs or those who have lost jobs have a very important decision to make regarding their 401(k)," said financial advisor Dan Wolodkiewicz, owner of Pinnacle Financial Associates in Beavercreek.

Wolodkiewicz (pronounced wal-oh-kay-witz) has one important piece of advice for people who are leaving a job with an established retirement plan. "Whatever you do, don't "cash out" because you could end up losing close to half of the value when you consider the taxes and penalties that may be involved." He acknowledged the loss in value, but suggested that might be limited to certain types of accounts.

"The downturn in the equity (stock) market was severe in the 4th quarter of 2008 and the 1st quarter of 2009," Wolodkiewicz noted. "Those who had a large portion of their investment portfolios in equities likely were the most adversely affected." Many 401 (k) plans contain equity investments either directly or as part of other types of funds.

A popular consensus among analysts is that employers will continue to reduce health and retirement benefits. In the near future, workers may hold sole responsibility for savings and medical plans - even if Washington continues efforts towards government-controlled health care.

The next few years will be crucial to anyone trying to save for retirement or other future financial security and rebuilding lost money will take planning and time. Wolodkiewicz advised, "Seeking out a financial advisor may be a good idea for many people who are faced with this decision."

Author Gery L. Deer is an independent journalist and columnist based in Jamestown, Ohio. Read more at www.gerydeer.com