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A NEW TREND: IMPROVED 401(K) PLANS
Q: I've recently read that 401(k)s need to be retired because of the many issues that arose during the financial crisis. Some think that the plans aren't a good savings vehicle and that the risk doesn't match the benefit in retirement. I'm currently putting in about 18 percent of income. I am considering reducing my contributions to capture the company match, 8 percent. I'm 36 years old. I have my emergency fund, but am still paying off my mortgage. What are your thoughts about this change? -- S.J., by e-mail
A: There's a really nice baby in the bathwater you're about to throw out. More important, we're starting to see a shift that will improve 401(k) plans significantly. Recently, for instance, I spoke to a group of employees at Texas Instruments. The first thing I did was congratulate them on having a plan that provided them with low-cost index funds for their investments, a recent change. This means TI employees won't face "manager risk" or the expense of high management fees in typical funds.
I think this is a trend.
In July, Business Week lauded IBM for revising its 401(k) plan to create the 401(k) plan of the future. What did it do? Among other things, its plan now offers a menu of index fund investments. Exxon-Mobil has had an index fund-based plan for many years. Ditto, the federal Thrift Savings Plan. Pretty soon, company managements will have to defend why they have expensive, managed fund-based plans.
Will this, or any other change, protect you from a bear market? No. If you want the returns you can get from equities, your retirement investments will have to contain some. And you'll have to live with the rough ride they sometimes give.
The important question for you is whether your particular plan offers good, low-cost choices. Or does it offer high-cost choices that will damage your long-term accumulation more certainly than a major bear market. If your plan is expensive, you should limit your contributions to an amount that captures the company match.
Q: Is it better to use a 401(k) loan at 5 percent to pay off credit cards than keep the 29 percent interest rate I have on a credit card? My job is fairly secure, so payback to the 401(k) should not be a problem, and our plan allows us to still contribute if we have an outstanding loan. I will destroy the credit card, but not close the account. The amount is about $18,000. -- S.D., by e-mail
A: I'd bet heavy money that there is no fund choice in your 401(k) plan that will return a certain 24 percent -- the difference between what you will pay on the 401(k) loan and the interest rate on your credit card debt. So, by all means, borrow from the plan. Pay off the credit card ASAP.
If you treated that $18,000 as a three-year loan at 5 percent, your monthly payment would be $539. If you tried to pay off the $18,000 while paying at a 29 percent interest rate on your credit card, it would cost you a great deal more. For instance, if you paid it off in the same 36 months, your monthly payment would be $754. That means you would pay an additional $7,734 in interest. If you made the same monthly payment as the 5 percent loan, you would have to make nearly 69 payments before the credit card debt was paid off. That would be about $17,787 for the extra 33 payments.
Either way, the interest saved is money you'll be able to use for other purposes -- such as investing more in your 401(k) plan.
Q: In the past, you have listed reliable Web sites for researching CD rates. Are there any current sites, and if so, which are the best? -- M.W., Austin, Texas
A: Here are some good Web sites to use for interest rate investing:
For CDs, www.bankrate.com and www.banxquote.com
For U.S. Treasury investments, www.bloomberg.com
For CD-like deferred annuity contracts, www.annuityadvantage.com
Questions about personal finance and investments may be sent by e-mail to scott@scottburns.com. Please visit my Web site at www.scottburns.com to comment on any of my articles, find referenced Web links or to discuss personal finance topics on my forums. Questions of general interest will be answered in future columns and on the Web site.
Scott Burns is a principal of the Plano, Texas-based investment firm AssetBuilder Inc., a registered investment adviser. The opinions of this article do not necessarily reflect the views of AssetBuilder Inc. This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, product or service.
