Those Invisible Risks in Some 401(k) Plans
If you’re one of the growing number of workers with a 401(k) company savings plan, take note: Some of your money may not be as secure as you think.
Many participants in the popular 401(k) plans choose to place most of their money in fixed-income investments, putting less money in stock funds. If you choose the fixed-income route, chances are that your money will be put into so-called guaranteed investment contracts, or GICs.
GICs are like bank certificates of deposit, promising a certain return--often 0.5 to 1.5 percentage points above yields on money market mutual funds--for a fixed period, usually one to 10 years.
Nearly two-thirds of every dollar in 401(k) plans--about $90 billion--is in GICs. Another $60 billion is in GICs through profit-sharing plans or other pension plans. And the amount is growing fast.
The problem is that the “guarantee” in GICs is not complete. It’s limited to the return that you are promised, not the safety of your principal. The contracts are offered by insurance companies, which invest the money in mortgages, privately placed loans and other investments that pay higher returns than Treasury securities. The U.S. government does not back these contracts the way it backs federally insured bank deposits.
Thus, your money is only as safe as the financial strength of the insurance company.
“They are low risk, but they are not risk-less,” says William D. Templeton, director of insurance consulting at TPF&C;, an employee-benefits consulting firm.
While there has never been a GIC default and no one has ever lost a penny in one, most employees have not been told of the potential risk. While most insurance companies offering GICs are big, reputable firms that invest conservatively and are given the highest financial ratings, some--such as troubled First Executive Corp. of Los Angeles--have invested at least a portion of their GIC funds in such high-risk investments as junk bonds and commercial real estate loans.
California is one of a handful of states without a guarantee fund that would reimburse at least part of your money in the event of an insurance company default. So a default could mean you’ll be out most or all of your money.
There’s also another risk: If your employer went under or engaged in a large-scale layoff, you might get back only the market value of your funds in a GIC, not their original value. If interest rates in the economy have risen, the market value will be less than the original value.
Should you avoid GICs?
Not necessarily. GICs are still safer than stocks. And you probably won’t have a choice of a safer investment anyway. As an alternative, a growing number of employers are using so-called bank investment contracts (BICs). But it’s not entirely clear whether federal deposit insurance would fully apply in a BIC default. And many banks--laden with risky foreign and real estate loans--are in worse shape than insurers.
Some employers offer money market funds as a 401(k) investment option, but it’s not easy switching into them from a GIC.
To discourage frequent switching, employers generally require you to transfer your money first into an equity fund for at least three months, Templeton says.
If it will help you sleep easier, check on the Standard & Poor’s, Moody’s or Best’s rating of the insurer or insurers offering your GICs. You can get that from your employee-benefits counselor or a good public library.
“Ask what the average quality of the portfolio is and what its expected performance patterns are going to be,” suggests Kenneth L. Walker, president of T. Rowe Price Guaranteed Asset Advisers, a firm that manages GIC accounts.
Bill Sing welcomes readers’ comments and suggestions for columns but regrets that he cannot respond individually to letters and phone calls. Write to Bill Sing, Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.
