MONEY

401(k) cuts now mean pain later

Whether or not the 401(k) is the nation’s best-designed retirement savings vehicle, for most people, it’s the only retirement plan they’ve got. Unfortunately, the most compelling feature about the 401(k) — the matching contribution from your employer — is disappearing fast. To save money, one-quarter of U.S. employers have eliminated matching contributions to employee 401(k) retirement plans since September, according to a recent survey of senior finance and HR executives by CFO Research Services and Charles Schwab.

Just how much does a company save by eliminating that benefit? Hewitt Associates ran the numbers in an April survey. For a company doing the typical match (50 cents for every dollar an employee contributes up to 6% of pay), the cost savings is about $1500 per worker. That can add up to a lot — anywhere from $2 million for a small company to $25 million for a large firm, Hewitt says.

This isn’t a new play. In past downturns, companies have been quick to cut their 401(k) matching contribution and have later restored the benefit when the economy improves. But that move takes a big toll on workers’ bottom lines at a time when they can least afford to take another hit to their retirement savings. Even a short-term halt in that contribution can have a long-lasting negative effect on your retirement savings. That’s because once the match is suspended, many employees reduce their own 401(k) contributions or even stop contributing to their plan entirely. As a result, employees’ retirement savings shrink by thousands of dollars. For example, younger workers earning $50,000 a year who contribute 6% of their salary will have $16,000 less for retirement than what they would have had if their employer hadn’t suspended their match for one year. That loss jumps to $48,000 if employees stops contributing during that year as well. While they may eventually start saving in their 401(k) again, Hewitt finds even a hiatus in savings of just a few years can deplete retirement savings by hundreds of thousands of dollars. For example, a younger worker earning $50,000 a year who stops contributing 6% of his or her salary for five years can have up to $150,000 less for retirement.

Clearly, just because your employer no longer kicks in to your retirement plan doesn’t mean you should stop too. Remember, your 401(k) is still a pretty good deal even without a company match. You get a big tax advantage by putting pre-tax dollars away for retirement, which lowers your current taxable income. And you don’t pay taxes on the gains in your plan until you begin withdrawing the money at retirement, which effectively gives you a higher after-tax rate of return than if you were in a taxable investment account. Sure, you can get similar tax advantages with a Roth or deductible IRA but you can only sock away $5,000 a year with those. With a 401(k), you can save up to $16,500 pre-tax in 2009. You can’t discount the convenience of having your retirement investments taken directly out of your paycheck either.

As for your employer, Hewitt suggests some other actions for companies to take to cut costs before slashing their company matches, including shopping around for funds with the lowest expenses and getting rid of costly printed materials which duplicate information found on company websites. For a thoughtful take on how 401(k) plans can be improved, read this piece by my colleague Penelope Wang.

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