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Making a Bad Situation Worse: Investing in 401(k)s without an Employer Match

01/09/2009 05:12 am ET | Updated May 25, 2011

The financial meltdown has caused a lot of employer belt-tightening. Many companies have stopped matching employee contributions to their 401(k) plans.

The securities industry, and many independent financial advisors, have mounted a vigorous PR campaign advising employees to continue to make contributions to their plans, even without the employer match.

Is this sound advice?

No. Not for most employees.

The 401(k) system was embraced by employers who wanted to abdicate their responsibility for funding the retirement of their employees. The securities industry saw an opportunity to capture huge assets.

Employers and the securities industry are partners in greed. Here's how it works:

The brokerage firms and other "advisors" offer "free" administrative services so the employer gets the plan at little cost. All they have to do is make a deal with the devil. The brokerage firms get to select the investment options from which the hapless employees are compelled to make their investment decisions.

You'll never guess which mutual funds predominate in these plans: high cost funds which are likely to under perform low cost index funds over the long term.

More fees for the brokers. No cost for the employer. Everyone's a winner.

Except the employee.

As a consequence, most employees make poor investment decisions and end up earning a fraction of what they could have.

You can't blame them. The system is rigged. They never really had a chance.

It gets worse.

Contributions to these plans are made with pre-tax dollars, which is touted as a great benefit. But distributions are taxed at ordinary income rates at the time of receipt. Participants in these plans are trading the historically lower capital gains rates in after-tax accounts for ordinary income rates.

Finally, there is the looming possibility of a change in the tax laws that could adversely affect these plans. When the government starts to look for tax revenues, the trillions of dollars sitting in 401(k) plans starts to look very appealing.

Congress understands these problems, but so far has done precious little about it. Maybe that's because members of Congress have one of the best 401(k) plans in the nation, the Thrift Savings Plan. No high costs or hyperactively managed funds for this plan. Just very low-cost Exchange Traded Funds and Target Retirement Funds. It is almost impossible to make a bad investment decision with this stellar plan.

If your employer stops contributing to your 401(k) plan, you should think very carefully about whether you should continue to participate. You have options.

Consider a traditional IRA or, better yet, a Roth IRA (if you qualify). Of course, you can always open up an after-tax account and invest the money you were contributing to your 401(k) plan in that account.

With any of these options, you are in total control of your investments--and your financial future. An added benefit is that you will no longer be part of system which was created and implemented to separate you from your hard-earned money.

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