Blackout rules not entire answer to 401(k) problems

This article was produced by the Financial Planning Association and provided by William O. Woody of Stovall Woody Associates.

The federal government has issued new rules that may reduce some of the problems that plagued Enron workers and others affected by "blackout" or "lockout" periods imposed by 401(k)-type plans. While the new rules may alleviate some problems, Certified Financial Planners caution plan participants to do much more to improve their employer-sponsored nest eggs.

The U.S. Department of Labor has issued interim rules that require all 401(k)-type plans to provide a minimum of 30-days' notice to plan participants before imposing a blackout period. The new rules go into effect Jan. 26, 2003.

A blackout period is when plan participants are restricted in their ability to buy or sell plan investments, take loans or receive distributions because the plan is changing administrators, investment options, or going through a merger or acquisition. Under the new rules, corporate executives will no longer be able to trade employer securities held outside of the plan or exercise stock options during the lockout a major criticism of what happened when Enron executives dumped falling company stock during their 401(k)'s blackout.

The plan sponsor must tell participants and corporate executives the reason for the blackout period, how long it will last and what rights will be restricted during the blackout. In addition, the sponsor must advise participants to evaluate their plan investments to see if they want to make any adjustments before the blackout begins.

Observers note that the new rules formalize what many employers are already doing with their plans. Furthermore, advance notice does not prevent what employees most fear a decline in the value of company stock during the blackout.

For example, despite a 60-day notice by Union Carbide Corp., its stock fell 29 percent during a blackout period in late 2001 and early 2002. In addition, some plans bar participants from selling company stock for a certain length of time after they receive it as matching funds, or before they reach a certain age.

This is why, despite the new rules, many financial planners say plan participants need to address far more fundamental investment issues than lockout periods. First, they need to take a much more active role in the management of their 401(k) accounts, such as studying the plan's investment options, stock sale restrictions and so on. Employees should base their plan's investment decisions on long-term needs and shouldn't be significantly affected by a lockout that lasts only a few days or weeks.

There are other key strategies that employees should address regarding their 401(k) or similar employer retirement.

Participation

Due to a sour economy, increased premiums for company health care plans and the bear stock market, participation in 401(k) plans is down 6 percent at large employers, according to PlanSponsor.com. Despite 401(k)-type plans coming under fire since the Enron scandal and the bear market, these frequently are the only vehicles for workers to effectively save for retirement. Participation is critical, particularly where employers put in matching funds; otherwise employees are leaving money on the table.

Company stock

Lockout periods have drawn attention because employees at Enron and other troubled companies were heavily invested in declining corporate stock. Yet plan participants in 318 of the largest 401(k) plans in the nation still have nearly a third of their plan assets invested in company stock and some plans average 75 percent in company stock, according to the Institute of Management and Administration. Planners recommend that most participants limit company stock to no more than 10 percent to 20 percent of the account's value, and some recommend maintaining even lower percentages.

Diversification

Not only are participants overloaded in company stock, they don't diversify well among the plan's other investment options, frequently limiting themselves to one or two mutual funds. Plus, some of those funds own large blocks of the employee's company stock or stock in the same industry. Consequently, if the company stock or industry declines, so may the mutual fund.

Cashing out

A majority of workers under age 35 cash out their 401(k) account's accumulated savings when they switch jobs, says the Profit Sharing/401(k) Council of America. The money thus faces income taxes and early withdrawal penalties, and can no longer grow tax-deferred.