If you don’t know exactly how your 401(k) or profit-sharing money is invested, keep bugging your employer until you find out. The workers at Color Tile Inc. certainly wish they had.
The Ft. Worth floor-covering chain is a painful example of how even a big-name company can mess up a retirement plan, quite legally. The retailer’s 401(k) plan went astray by investing heavily in Color Tile’s own stores, which it then leased back to the company.
Bad idea. Color Tile slipped into Chapter 11 bankruptcy-law proceedings this year. Some stores stopped paying rent to the plan. Many workers have been laid off and need money. But none is allowed to tap the money in the 401(k) plan.
“I was counting on the money,” says Truman “Buck” Buchanan, a former buyer for a Color Tile store in Ft. Worth who had accumulated $97,000. Just six months from when he had hoped to retire, he is collecting unemployment and biting his nails.
How to avoid such an outcome? Look out for problems in your 401(k) or profit-sharing plan. We’re not talking about fraud or theft here, just lousy investments. Many people imagine that these plans stick pretty much to plain-vanilla mutual funds. But that is the case primarily at the largest companies, with their menus of fund choices. When the boss picks the investments, watch for these caution flags.
– Company real estate. If your employer has a hunger for real estate–perhaps it’s a retail chain, or a business eager to expand–beware of a loophole in federal law that enables your employer to invest as much as 100 percent of plan assets in property that the company uses in some way. Color Tile was merely following in the footsteps of Dallas-based Southland Corp., whose plan currently owns hundreds of 7-Eleven stores, accounting for some 46 percent of plan assets. Old-style pension plans are limited to 10 percent.
There are some restrictions. Your employer is still supposed to make sure the investment is “diversified,” which means the real estate must be in various geographic locations. But a lot of plans are tempted to ignore that.
Even if the real estate purchase is legal, and it often is, this doesn’t mean the investment is a good one for you. The high costs of real-estate investing–taxes, mortgage interest, upkeep, brokerage fees–can eat into your returns. Since 1991, for example, the average annual return in the Southland 401(k) plan has been only 8.16 percent a year.
Donald Trone of Callan Associates Inc., a San Francisco firm that advises retirement plans says, “The law partner may want to invest in real estate, but the paralegal and the secretary bear the costs, too.”
– Vaguely described investments. Employees of Color Tile say they never knew that so much of their savings wound up in company stores. Some say they relied on a company video describing their 401(k) plan. In the video, the narrator says that the money is “invested in a diversified portfolio, a mix of real estate, stocks and bonds.” There’s nary a peep about company stores. But the video says: “Your contributions belong to you. . . . Should you leave the company, these funds are yours.”
The video goes on to assure employees that “the money is held separately from the company. The assets are held by a major bank and are never part of the company’s assets . . . the bank and the (investment committee) have a responsibility to invest the plan prudently.”
Paul Locke, 24, says he never would have saved $5,000 in the plan if he knew it was more than 80 percent invested in Color Tile stores, especially last year, when the company was rumored to be in financial trouble.
Don’t rely on videos, verbal assurances or even the summary plan description the employer is supposed to give you. Ask the boss to disclose, in writing, exactly what the investments are. And make sure you understand what they are.
– Too much employer stock. Another legal loophole allows 401(k) and profit-sharing plans to have as much as 100 percent of assets invested in the stock of the employer. Even where there’s a choice of investments, many employees still end up overloaded with their employer’s shares.
Consider the results of a survey released recently by the Institute of Management and Administration in New York, which publishes newsletters about “defined-contribution” plans. It reveals that despite the bull market in stocks, for the 12 months through March, losses were posted by 16 out of 236 employer stocks that were included as options in defined-contribution plans. In addition, plenty underperformed the market, including Abbott Laboratories (92 percent of plan assets), Amoco Corp. (70 percent), Walt Disney Co. (63 percent), Dominion Resources (75 percent), Westvaco Corp. (90 percent), Weyerhaeuser Co. (65 percent) and Procter & Gamble Co. (93 percent).
– Investment novice in charge. You may find out that the boss is the one making all the investment decisions, even though that boss is trained as an anesthesiologist, divorce lawyer or engineer. One gynecologist at a Washington-area practice fancies himself an amateur Peter Lynch, says a dubious patient, who happens to work for the Labor Department.
– Financially strapped employer. That big pot of retirement plan money is oh-so-tempting. You may discover your 401(k) plan “investments” include loans to the employer or to related businesses. You may not be getting a good return on your money, even if the loans are legal.
Lawyers say the legality of such loans is a gray area. For instance, a struggling company in Deerfield Beach, Fla., borrowed $1.6 million from the 401(k) plan, and didn’t pay the money back. The Labor Department is suing the trustees to have the losses restored.
– Complex instruments. If you’ve never heard of the investments, you may have a problem. Employers often rely on their friendly broker for advice. When that happens, the plans can become a collection of financial accidents. Be wary of limited partnerships, penny stocks, tax liens, mortgage-participation notes or life insurance purchased as a retirement-plan investment.
You probably shouldn’t lose sleep if your plan has mainstream investments such as mutual funds, guaranteed investment contracts and annuities, and you can choose how to move the money around. And in 403(b) plans for non-profit companies’ employees, special rules prevent plans from straying beyond mutual funds and annuities.
But if your employer makes the investing decisions, and the investment is mysterious, find out more before you fork over a portion of your paycheck.
