401(k) Loan/Debit Card: A Bad Idea in General. But What if as Last Resort?

Everybody agrees in general that a 401(k) loan or a 401(k) debit card is a bad, bad idea. For those of us who don’t have a guaranteed pension plan and can’t rely on social security, 401(K), as well as other individual retirement savings accounts, is one major tool to save for retirement when our pre-retirement incomes stop.

Since the money in the 401(k) account is for retirement, not for daily expenses, the government imposes an extra 10% penalty to discourage early withdrawals from the account. However, as the credit crunch goes on and home value keeps falling, more and more people start to have a hard time paying their bills or face losing their homes to foreclosure. At the same time, the cost of living is going nowhere but up: food, gas, health care, education, etc., things are getting expensive. Then there comes the creative idea of using a 401(k) debit card to borrow money from retirement accounts such as 401(k) to stay afloat, just like withdrawing cash from your private ATM machine.

I recently read quite a few articles on how a growing number of people are taking money out of their 401(k) accounts to save their homes. For example, in this USA Today story, Tamara Campbell, who lives in a Denver suburb

raided her 401(k) after her husband was laid off from his job as an occupational technician, and they fell behind on their mortgage for several months. “If I hadn’t done that, we would have been foreclosed on last year.”

Late last month, The Wall Street Journal reported that a survey among 2000 full-time workers conducted by Transamerica in 2007 found “49% of those who borrowed from their retirement savings said they took the loan to pay off debt, up from 27% in 2006.” And there are strong correlation between foreclosure rates and 401(k) loan or hardship withdrawal rates in regions of country where home prices are hit hard.

And for those who took money from their 401(k) accounts, not only they have to pay penalties and interests, but also could face shortfalls when they retire. Take a look at this example from The Wall Street Journal:

A participant with a $20,000 account balance who contributes $100 a month and earns an annual return of 10% would have $624,681 after 30 years. But if that participant borrows $10,000 from his plan and repays the loan at 7% interest over five years, halting contributions while he repays the loan but making $100 monthly contributions for the next 25 years, he would have only $523,502 at the end of the 30-year period.

Despite all the serious consequences of withdrawing from 401(k) accounts, if you are in a situation that you could lose your home if you can’t keep up with your mortgage payments, but have, say, $100K in your 401(k) account, would you withdraw from your 401(k) to save the roof under which you and your family live?

I would, as a last resort.

If that’s what you decide to do, then take this advice from The Wall Street Journal article:

If participants decide they must take out a 401(k) loan, they should aim to pay it off as quickly as possible and continue making new plan contributions while paying off the loan, taking full advantage of any employer-matching contributions.

Just like paying any debt requires responsibility and discipline, the same applies to 401(k) loans but with increased urgency.

photo credit: lomorajue

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Yes, I Can Sue My 401(k) Administrator

According to a NY Times article (registration required) yesterday, the US Supreme Court has ruled on February 20th that workplace retirement plan participants can sue the plan administrator to recover their losses under the Employee Retirement Income Security Act of 1974.

The case, LaRue vs. DeWolff 06-856, is filed by James LaRue of Southlake, Texas, who in the lawsuit claimed that “the value of his stock market holdings plunged $150,000 when administrators at his retirement plan failed to follow his instructions to switch to safer investments.”

In the ruling, Justice John Paul Stevens said that such lawsuits are allowed:

Fiduciary misconduct need not threaten the solvency of the entire plan to reduce benefits below the amount that participants would otherwise receive.

Is this a good news? Maybe, but I am not sure how much I can blame my 401(k) administrator for any loss of my investment because I myself manage what to invest. Seriously, a loss of $150,000 in a 401(k) plan is not going to happen over night. I wonder what that guy was doing when his account was shrinking.

Update: From the lawsuit:

Petitioner alleged that in 2001 and 2002 he directed DeWolff to make certain changes to the investments in his individual account, but DeWolff never carried out these directions. Petitioner claimed that this omission “depleted” his interest in the Plan by approximately $150,000, and amounted to a breach of fiduciary duty under ERISA.

*Photo from Wiihaveaproblem.com

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Roth 401(k)

My wife’s employer started to offer Roth 401(k) plan through Fidelity this year. While it’s good to know that there’s a new saving vehicle available, we decided not to participate after examining the pros and cons of the plan at that time. The main reason was that it doesn’t offer more benefits than the traditional pre-tax 401(k) plan that she is maxing out. Our decision could change next year though, depending on our tax situations.

Looking at the plan itself, the way it works is quite similar to Roth IRA plan, i.e., contributions are made from after-tax dollars, earnings can grow tax-free, and withdrawals at retirement (59.5 years or older) are exempted from income taxes. However, the annual contributions are subject to IRS limit. For 2007, the combined contributions from both pre- and after-tax accounts cannot exceed $15,500. Thus, from the point of view of maximizing savings, adding a Roth 401(k) plan won’t help us save more. In addition, as an employer administrated plan, the investment choices Roth 401(k) offers are limited. At this point, it’s not very attractive to us.

Then what’s the benefit of this new plan? The key selling point seems to be the tax-free withdrawal at retirement. Compared to traditional 401(k) plan, the difference between these two is whether to pay taxes now (Roth) or later (traditional). The decision on which plan to use thus depends on what is going to happen with tax rate. If the tax rates declines in the future, pre-tax 401(k) account makes more sense since withdrawals at retirement will be taxed at a lower rate. If things are going in the opposite direction, one will be better off making after-tax contributions now to take advantage of the current rate. The problem is, of course, nobody knows for sure what tax rates will be 10, 20, or 30 years from now.

Besides the tax issue, Roth 401(k) does give high-income earners who are not eligible to contribute to Roth IRA a way to save for retirement as there’s no income restrictions on Roth 401(k) participants. Roth IRA, on the other hand, starts to phase out for joint filers with incomes between $156K and $166K.

Last April after we filed our taxes, we had to withdraw all but $200 of our 2006 Roth IRA contributions as we were in the phase out range. For 2007, the phase out range is a little higher than that of 2006 and there are several weeks that I was unemployed. Therefore, our income this year may not exceed the threshold. We will need to wait till next January after the income data is in to see if my wife should participate in the plan or not next year.

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• Key Differences between Traditional and Roth IRA

Reader Question: What to Do if a Bear Market is Coming?

The recent market plunge has generated quite some debate among PF bloggers what we should do (if we should do anything at all) with our investments in the event that major indexes lost 5% in just a couple of days:

• Should we see it as a buying opportunity?
• Should we re-evaluate our investment strategy?
• Or should we simply do nothing?

If you ask me, I would say it was nothing but a buying opportunity if you already have something on your mind and just wait for the right time to enter (I bought 70 shares of VBR the day after the sell-off); otherwise, I won’t do anything special. 500 some points drop in one day is big. But if you put it into the perspective of long-term investment, a short-term decline, even at the 5% magnitude, is probably nothing and, therefore, doesn’t warrant a upside-down overhaul of a portfolio.

Yesterday, I received an email from a reader that brought up the question of what to do if a bear marketing is coming (Greenspan saw a 33.3% chance for a recession this year):

I spent 10 years in the military and separated with no retirement, 401K, or home equity. In the past 6 years I have managed to invest my money and accumulate about $45,000 in my 401K. I have managed my own funds and averaged an 11% return annually since 2001. In November, I moved all my 401K to cash (in a money market account) to lock in my gains, (except new money, they are still allocated into my different funds) because I feel like I have some catching up to do due to my years in the military accumulating nothing. Now that the market has somewhat corrected, should I redistribute my monies back into stocks or does everyone feel like a bear market is coming and I should wait? Just curious.

For me, knowing that I won’t be using the money in my retirement accounts in another 30 years, I won’t do anything dramatic even if a recession is on the horizon (but who can predict that anyway?). I’m fine with increasing the cash portion of my portfolio if I am not confident with the direction the market is heading, but wait and stop participate is not an option.

What will you do in this event? Escape or stay the course?

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Citi Elite PremierPass Card Received

A little over a week ago, I applied a Citi Elite PremierPass credit card after seeing some discussion on FatWallet forum. What interested me were

1. the promise of no annual fee, which is usually $75,
2. 15,000 bonus points after 1st purchase, and
3. 0% balance transfer for 12 months

At the time when I applied for the card, it wasn't very clear whether the fee is waived temporarily or permanently. Today, the card arrived with a credit limit of $19,500 and on the card carrier it is clearly printed "Annual Membership Fee: NONE" with no any other conditions attached, the same as every other Citi card I have. As long as there is no annual fee, this is a very good card for travel, though I don't travel that much. If they change their mind later, I can always cancel the card. 

Right now I am only interested in making a purchase to get the bonus points, then make a $19,000 balance transfer. For 12 months, the interest-free loan could earn me about $1,000 in interests with IGoBanking's 5.30% APY. Though for this deal, I have to pay a maximum of $250 balance transfer fee, the free money is irresistible.

This offer, however, is dead as the annual fee is no longer waived on the new card application page.

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A Better Way to Invest in 401(k) and Get Better Return?

I got this idea when I was visiting MoneyMonk yesterday and reading his post on saving a little more in 401(K) by contributing 20% for the first three months and 12% for the rest nine months of the year. Since I started to contribute to my 401(k) plan, I always set a fixed percentage point at the beginning of the year the forget about it until next January. This is the same as I do dollar-cost-averaging (DCA) in my taxable mutual fund investments: automatically contribute $100 to each fund at the beginning of the month. 

However, in the wake of my recent little study of DCA which shows that DCA every month may not give me the best returns as compared to other investment schemes, I think I want to make some adjustment on how to contribute to my 401(k) using the same method as what MoneyMonk uses. Since the deduction from my paycheck is on a biweekly basis which I can't change, I can set a higher contribution percentage for the first half of the year, then switch to a lower percentage later so I won't exceed the contribution limit. If history is a guide, I can purchase more shares with the same amount of money early in the year than what I will get later in the year assuming the trend of the overall market is up for the next 10, 20 years. By contributing more early, the long-term performance should improve, especially for a 401(k) account which I will hold for decades before withdrawing any money out of it.

Is this a better way to invest in 401(k) and get better return? I have no way of knowing it, but it's worthy trying.

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401(k) Performance: Trader vs Rebalancer

Everybody trades, more or less, and I do too. For me, most of the trades were in brokerage accounts with individual stocks. For mutual fund accounts, there were far more buys than sells. But for 401(k) account, so far there seemed to be only buys, no sells. Actually, the only activities in my 401(k) plan besides regular contributions were moving assets among funds within the plan, i.e., reallocating different assets classes to maintain the target allocation (the target itself may change over time as, for example, you are moving close to your retirement).

There are a lot of talks about the importance of rebalancing. And the main argument is to prevent an asset class from growing too big because it’s hot, thus reducing the risk of getting hit hard when it cools off. To rebalance, assets that grows above the target percentage level should be transferred to underperforming areas to maintain the overall allocation target. By rebalancing, you also buy low (underperformers) and sell high (outperformers), instead of buying high and selling low (sell underperformers and add the money to outperformers). For me, since all my taxable mutual fund holdings are with mutual fund companies, rebalancing is not very easy because it can only be done by selling one fund at one company and using the money to buy another fund at a different company and this will incur taxes due to capital gains from the transactions. With 401(k) plan, on the other hand, rebalancing isn’t a tough job as most people have their accounts with a single company and moving assets around won’t have a impact on the tax bill.

If rebalancing is so easy, how many of us rebalance our 401(k) plans? Apparently not a lot. According to David L. Wray, president of the Profit Sharing/401(k) Council of America (PSCA), “The most common employee investment mistake is not rebalancing.” While most of us stay idle with our 401(k) plans, there are a small number of employees on the other side of the spectrum do more than just rebalancing. They actively trade in their 401(k) plans, though the frequency may not be comparable to the trading activities in brokerage accounts.

Now based on the activities in their 401(k) plan, we have three groups of employees: an idle majority, a rebalancing minority, and a small group active traders. How do these groups compare to each other when it comes to 401(k) performance? The answer can be found in a research paper published last month by the Pension Research Council at The Wharton School of the University of Pennsylvania. The paper, “Winners and Losers: 401(k) Trading and Portfolio Performance,” highlights the performance difference between traders and rebalancers based on “a unique new data set of about one million active 401(k) participants in some 1,500 DC plans.” (DC: defined contribution). While observing that “the dominant trading behavior in 401(k) plans is not active or even somewhat inactive trading, but rather nontrading trade at all,” the main conclusion of the study offers the benefits of rebalancing or choosing a lifecycle fund in 401(k) plans:

…… certain types of trading such as periodic rebalancing are beneficial, while high-turnover trading is costly. Interestingly, those who hold only balanced or lifecycle funds, whom we call passive rebalancers, earn the highest risk-adjusted returns.

Furthermore, 401(k) rebalancing is “a particular beneficial strategy on a risk-adjusted basis.”

Passive rebalancers, or investors who hold only balanced or lifecycle funds and leave trading to the fund’s portfolio manager, realize excess annual returns of 84 basis points on a risk-adjusted basis.

while

Active rebalancers, who move their 401(k) portfolio’s equity allocation back to a given target on their own, earn 26 basis points in excess risk-adjusted returns.

For the small group of employees who are actively engaging in trading in their 401(k) plans, the study found that “while some degree of trading is a return-enhancing trading strategy, very high portfolio turnover is not,” and

as a group, traders outperform nontraders when returns are not risk adjusted. But because traders assume higher portfolio risk, the difference in returns between the two broad groups disappears after adjusting for risk. …… Among those who trade, investors who most actively churn their accounts lose 72 basis points per year compared to traders with the lowest turnover ratios.

Finally, the paper suggests that

In view of the clear rewards from rebalancing as an investment strategy, plan sponsors should ask whether using an automatically rebalanced account should become the default. …… since we find that high turnover rates in 401(k) plans harm investment performance, it would appear that discouraging active trading would produce superior risk-adjusted returns and ultimately higher retirement savings.

An example of rebalancing: Suppose that at the beginning of 2005 I set my target asset allocation (Morningstar’s X-ray is a good tool to check asset classes and allocations) as:

• Large Cap - 30%
• Mid Cap - 10%
• Small Cap - 20%
• International - 20%
• REIT - 10%
• Bonds - 10%

that is, I had 90% of my total assets in equities and 10% in bonds, which I think is a proper percentage for my age. At the end of the year, I reviewed my asset allocation and fount it changed to

• Large Cap - 20%
• Mid Cap - 10%
• Small Cap - 25%
• International - 25%
• REIT - 15%
• Bonds - 5%

due to strong performance in the small-cap area, robust growth of economies outside the US (international), and continuous housing boom (REIT), while the large-cap portion, mainly invested in blue-chip stocks, has lagged (not necessarily lost 10% of values, but rather shrank in size relatively). So did my bond investments. To bring the allocations back to the target, at the end of 2005 I had to sell (or transfer) part of my small-cap and international positions to large-cap investments and move some money out of the real estate market (REIT) to buy some more bonds, anticipating a slowdown in the housing market. After the rebalancing, my asset allocation returned to the target percentages and if 2006 turned out to be a good year for large-cap stocks (as it could be from what we saw now), I added some when they were cheap (therefore the return could be even higher) and locked in some gains in small-cap and international stocks when they were hot.

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23% Company Stocks in 401(k)

My wife has been with her current company for nearly five years and her employer offers a match for the first 6% of her 401(k) contributions. The only catch is the match is given in company stocks in the form a fund. Ever since she joined the company, she maxed out every year and now a sizable amount of her company stocks, while the resets are in Fidelity mutual funds. Last week, when reviewing her portfolio, we found that nearly 23% of her 401(k) is in her company’s stock fund! Though it's nice to have an employer giving generous matches, the percentage is really at an uncomfortably high level which could be a problem in long term.

So we decided to trim the holding to 5 – 10%. When we tried to exchange the company stock fund to other mutual funds she currently holds, an error message popped up, saying employer sponsored contributions are not eligible for such transactions. Next day, my wife called Fidelity and was told that, according to the current rule, employees have to hold the company match portion before they are 50! That’s more than ten years away and anything could happen to the company during this awfully long period of time. One exception is that portion can be traded if the employee leaves the company. Fidelity also said the rule is currently under review and changes may be made. But nobody knows when that will happen despite that the new Pension Protection Act 2006 bars companies from forcing employees to invest any of their own retirement savings contributions in company stock. For now, there's nothing we can do but hoping that her company doesn't run into any trouble.

P.S. According to Fidelity, the new pension law

Gives workers the right to sell publicly-traded company stock in their retirement plan account after 3 years of service for matching contributions, and immediately for employee contributions. Also prohibits companies from forcing employees to invest any of their own retirement savings contributions in company stock.

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Am I Paying Too Much for My 401(k)?

An article in yesterday's USAToday prompted to check the fees I paid for those funds in my 401(k) plan. Unlike mutual funds holding in my taxable accounts, in which I have the flexibility to choose from perhaps hundreds of funds in the same category from as many companies, the number of funds in my 401(k) plan, which is managed by Fidelity and, thus, are all Fidelity funds, is limited. This means sometimes I have to pay more in fees in order to get the diversification I want. For taxable accounts, the wide selection makes  it possible to go after low-fee funds, not so for 401(k) plan. Not that I don't care for various fees I have to pay to own the fund (I admit that I didn't pay much attention to fund expenses in my 401(k) plan), I just don't have better alternatives. For example, I currently have four funds in my 401(k) and from the date provided by Fidelity, the fee structures of the four funds are:

Fund	Managemnet fee	Expense ratio
Freedom 2035 (FFTHX)	0.01%	0.75%
Small Cap Retirement (FSCRX)	0.62%	1.06%
Small Cap Value (FCPVX)	0.81%	1.09%
Real Estate Investment (FRESX)	0.57%	0.83%

Though there are two columns of fees for each fund, what really matters is the expense ratio (ER). According to Investopedia definition, mututal fund expense ratio is

The percentage of total fund assets that is used to cover expenses associated with the operation of a mutual fund. This amount is taken out of the fund's assets and lowers the return that fund holders achieve. These expenses include management fees and operating expenses. The management fee is the fee that is charged to the fund by the portfolio manager, and it is often a fixed percentage. The operating expenses are the expenses that the fund incurs through operation and this can include brokerage fees, taxes, investor services and interest expenses.

That is, management fee is part of the overall mutual fund expense ratio, which also incudes administrative costs and 12b-1 distribution cost (the fee that mutual fund company collects from investos to advertise the fund). Using the NASD Mutual Fund Expense Analyzer, I calculated the costs of own $10,000 of the above four funds for 10 years, assuming a reasonable 8% annual return:

Fund	10-yr value	10-yr expenses	10-yr value	20-yr expenses
FFTHX	$20,035	$1,079	$40,140	$3,240
FSCRX	$19,448	$1,483	$37.882	$4,369
FCPVX	$19,371	$1,536	$37,524	$4,513
FRESX	$19,876	$1,188	$39,508	$3,550

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Six Ways to Boost Your Savings by Making the Most of New Tax Law

I ususally don't read very carefully the newsletter Fidelity sends to me as I see it as an advertisement. But an article in today's E-News got my attention. It's about how to take advantage of the new tax law passed in August to boost savings. Below is the summary of the article, click here for details.

• Workplace Roth 401(k) and Roth 403(b) features become permanent: If your employer offers Roth 401(k) or Roth 403(b) feature in your plan, you can after-tax contributions to the plan directly with your paycheck deduction.
• Automatic enrollment eliminates savings inertia: Starting 2007, the new tax law allows employers to automatically enroll their employees in retirement plans, unless you opt out the program.
• Qualified plan rollovers to Roth IRAs simplified: Beginning in 2008, if you're eligible to make a Roth IRA conversion, the new law will allow you directly rollover your retirement plan, such as 401(k), 403(b), and governmental 457(b), into a Roth IRA.
• Income limits for Roth rollovers gone in 2010: For couples with more than $100,000 in modified adjusted gross income, they can wait till 2010 to convert an assets to Roth as starting in 2010, the income limit for Roth conversions will be eliminated.
• Guidelines for giving investment advice: Starting in 2007, you can seek professional investment advice for your retirement plans.
• Contribute more to your IRA: Starting from 2008, the annual IRA contribution limit increases to $5,000. After 2008, the $5,000 limit is indexed for inflation, which means your IRA contributions will be increased for cost of living changes.

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Year-to-Date 401(k) Return

I usually don't check my 401(k) account until the time to update the net worth and even at that time, I didn't look at the return because, first, I simply forgot to check and, second, I won't make any change before the year end, no matter how good or bad the return is. But tonight, I logged into my 401(k) account at Fidelity and found that the year-to-date return is 8.4%, slightly ahead of the S&P 500, which has increased about 8% so far this year. 

I have a very simple portfolio in my 401(k) account, with only four funds

and the Fidelity Real Estate Investment (FRESX) was only added early this year to give it a little more diversification. For this portfolio, most of the diversifications come from Fidelity Freedom 2035 (FFTHX), which is a targeted retirment fund. An instant X-ray from Morningstar shows the asset allocation of my 401(k) as 

with an expense ratio of 0.89%. 

The two small-cap funds were added because FFTHX itself doesn't have enough small-cap exposure (only about 5%). Overall, about 20% are invested in small-cap companies, 21% in mid-cap, and 59% in large-cap. However, I still feel that the 20% in small-cap is a little bit low and would like to see it at 25% level at least. This will be the task of rebalancing at the end of the year.

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A 8-Step Course for Your Personal Finance from CNNMoney

As we entered the last quarter of 2006, there are some articles recently offering advices on how to get your personal finance in order at the end of the year and be prepared for 2007. For me, there are at least three things I plan to do for our investments before year end:

• Rebalance both taxable and tax-deferred investment plans;
• Max out 401(k) and Roth IRA contributions;
• Add money to 529 plan;

Today, there is another piece from CNNMoney that offers a 8-step course:

1. Rebalance your 401(k): Rebalance to keep each asset class within its target allocation, but don't make any upside-down change.
2. Revisit your estate plan: Review your will, add any new property, check your giving plan, and make sure that your guardianship plan for your kids still makes sense.
3. Sock it away: Maximize your IRA contributions and keep cash in high-rate accounts which are not difficult to find.
4. Give smarter: Keep a list of items you donated or want to donate and assess the fair values of your non-cash donation; otherwise, you may pay more penalty for overstated your donation under the new pension law.
5. Review your health plan: Be sure to sign up the flexible-spending account when you renew you health care plan.
6. Clean up your taxable account: Dump some hopeless losers before the year end to offset capital gain/dividend incomes that will be taxed. Best of all, the loss can be carried over into 2007. But be aware of the wash-sale rule.
7. Do a property insurance checkup: Don't be under-insured!
8. Check the new credits and taxes: New "kiddie tax" rule: for kids under 18, their annual investment income will be taxed at their parents' rates if it's above $1700.

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Save now, Girls!

I came across an article on SmartMoney.com the other day titled “The Girl’s Guide to Retirement,” and there are some interesting numbers in the article that caught my attention.

Everybody knows women are expected tend to live longer than men (on average five years longer), yet when it comes to retirement expectations, women usually underestimate the amount they need in order to maintain their pre-retirement life style. For example, according to the article, a recent survey found that nearly 37% of women believe they can live comfortably with only $250K for retirement. On contrast, nearly a quarter of men surveyed said they need at least $500K to a million. What’s more shocking is that 42% of women in the survey said they have less then $10K in all their retirement saving accounts (401K and IRA)!

What to do?

Buy fewer shoes and save more for retirement!

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Hire a Financial Advisor for Your 401(k) Plan?

Confused about what to invest in your 401(k) plan? Maybe a financial advisor can help. 

I always thought that how to invest in my 401(k) is my sole responsibility. Even when sometimes it seems confusing in making the right combination (not to mention maximizing returns), I never thought about seeking professional assistance. First of all, I didn't know whether or not I could; secondly, there's noway my employer could offer any advice for whatever reason (conflict of interest? or being held accountable for the outcome of the advice?) So I was surprised when I learned this morning from an article in this month's Kiplinger's Personal Finance magzine that starting January 1, 2008, employees can indeed heir investment advisors for how to invest in their 401(k) plans. 

Under the The Pension Protection Act of 2006, employees can obtain financial advice as long as the advice is either based on a computer model, or from an authorized advisor who's commision is not tied to the investment products being recommended. On top of that, 

… the qualified investment advisor can be paid out of the taxpayer's retirement account (such as a 401k, IRA, or other plan) without incurring a penalty or tax for distribution from the plan.

Though I'm not going to heir anybody for my 401(k) investment any time soon, it's nice to know that I have this choice.

Details about the next tax law can be found here, but the following is the portion that concerns 401(k) plan. 

Individualized investment advice

Under a new prohibited transaction exemption, qualified "fiduciary advisers" are allowed to offer personally tailored professional investment advice to help employees manage their 401(k) plans, individual retirement accounts (IRAs), and other plans. The fiduciary adviser may be affiliated with the investment funds offered in a 401(k) plan but would have to meet disclosure, qualification, and other self-dealing safeguards. Further, if these conditions are met, employers or plan sponsors would not be obligated to monitor the specific advice given to any particular participant or beneficiary, though they would retain the responsibility to prudently select and monitor advice providers.

Individualized investment advice may be provided to 401(k) plan participants, without running afoul of the prohibited transaction rules, if fiduciary advisers provide investment advice under an "eligible investment advice arrangement." Such an arrangement is one under which (1) portfolio recommendations are generated for a participant based on an unbiased computer model that has been certified and audited by an independent third party, or (2) fiduciary advisers provide their investment advice services by charging a flat fee that does not vary depending on the investment option chosen by the participant.

The Secretary of Labor, in consultation with the Secretary of the Treasury, has been directed to determine whether investment advice provided through a computer model would be feasible for individual retirement accounts and individual retirement annuities (IRAs), medical savings accounts (Archer MSAs), health savings accounts (HSAs), and education savings accounts (Coverdell ESAs). The DOL determination must be made by the end of 2007.

If the Secretary of Labor determines an appropriate model is available for such plans, a computer model, certified by the Secretary of Labor, will be an option for providing investment advice for such plans. If the Secretary determines that an appropriate model is not available, the Secretary has been directed to grant a prohibited transaction exemption that protects account holders from biased advice without requiring fee-leveling or a computer model. The exemption will sunset on the later of two years after an appropriate computer model becomes available, or three years after issuance of the exemption.

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No Choice: Have To Keep Company Stocks

My wife has been with her current company for nearly five years and her employer offers a match for the first 6% of her 401(k) contributions. The only catch is the match is given in company stocks in the form a fund. Ever since she joined the company, she maxed out every year and now a sizable amount of her company stocks, while the resets are in Fidelity mutual funds. Last week, when reviewing her portfolio, we found that nearly 22% of her 401(k) is in her company’s stock fund! That’s a very high percentage and could be dangerous in the long term.

So we decided to trim the holding to 5 – 10%. When we tried to exchange the company stock fund to other mutual funds she currently holds, an error message popped up, saying employer sponsored contributions are not eligible for such transactions. Next day, my wife called Fidelity and was told that, according to the current rule, employees have to hold the company match portion before they are 50! That’s more than ten years away and anything could happen to the company during this awfully long period of time. One exception is that portion can be traded if the employee leaves the company. Fidelity also said the rule is currently under review and changes may be made. But nobody knows when that will happen. For now, my wife has to keep her company stocks for a while. A long, long while.

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