Limit company stock in 401(k) plans

It's not often that we face a big problem with a simple solution. The problem is that employees hold too much of their employers' stock in their 401(k) plans. The solution is to extend to 401(k) plans the provision that limits employer stock to 10 percent of the portfolio in conventional defined-benefit pension plans.

Two high-profile cases - Lucent Technologies and Enron Corp. - have driven this problem home. Lucent cut 30,000 jobs this year. A large number of the displaced workers had invested a significant portion of their retirement resources in company stock, and some had their entire 401(k) plans invested in Lucent shares. The value of Lucent stock declined 91 percent between 1999 and 2001, which meant many of those who lost their jobs also faced devastating declines in their retirement holdings.

The implosion of the Enron Corporation has also wreaked havoc with its 401(k) plan, which at the end of last year had $1.3 billion (62 percent of the total) invested in Enron shares. Since that time, Enron stock rose to more than $80 a share and then collapsed. As Enron's stock hovers near zero, its 11,000 employees who participate in the 401(k) plan have seen their retirement holdings drop by more than 60 percent at the same time that they face unemployment in a depressed labor market.

Any financial planner would say that investing more than half of retirement assets in employer stock makes no sense. Given the benefits of diversification, allocating so much to one company is troubling even if that company were not the employer. But participants are not only concentrating their assets in a single stock, they are also investing in a security that is closely connected with their earnings. Putting all their eggs in one basket makes employees extremely vulnerable if the company runs into trouble.

Yet this practice is widespread. About 2,000 companies, covering 6 million of the nation's 40 million 401(k) participants, offer their own stock as an option in the company's plan. A significant number of companies virtually compel their employees to invest in company stock by making their matching 401(k) contributions in that form. Moreover, many of the companies making company stock contributions restrict employees from selling the stock until they near retirement.

When the company is prospering, company stock looks like a great deal. For employers, it is an easy way to meet 401(k) contributions. Employers also argue that it increases worker commitment and productivity. For employees, company stock is a way to cash in on hard work by sharing directly in the growth. But when the tide turns, the costs of excessive investment in company stock are evident.

The risks of investing retirement money in company stock have long been known. Financial advisers generally suggest that employees invest no more than 10 to 15 percent of their portfolio in their employer's stock. The 1974 Employee Retirement Income Security Act (ERISA) allows only 10 percent of pension assets in defined-benefit plans to be invested in company stock.

The time has come to extend ERISA's diversification rules to 401(k) and other defined-contribution plans. This change cannot help the laid-off workers at Enron and Lucent, but it will help 401(k) participants in the future.

Alicia H. Munnell is Peter F. Drucker Professor of Management Sciences, Boston College Carroll School of Management.

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