For nearly two decades, Money magazine has been urging readers to make the most of their 401(k) plans. But we've also warned about their flaws. The biggest one: company stock.

Make no mistake, company stock is a ticking time bomb in many 401(k)s. At McDonald's, Coca-Cola, Abbott Labs and Procter & Gamble, for instance, employees have even more company stock in their retirement accounts than Enron staffers did -- 74 to 95 percent of plan assets. And if you think these employees aren't vulnerable, remember back to 2000, when an earnings dip crushed P&G's stock by 54 percent. The whole city of Cincinnati felt the pain.

America has become ever more reliant on our 401(k)s -- and when they tremble, the whole retirement system is threatened. No wonder the Enron debacle has politicians holding all those hearings in Washington and floating proposals to limit company stock in retirement plans or to make it easier for employees to unload their shares.

Here is what you need to know about company stock now -- from how it came to play such a large role in 401(k)s to what is likely to emerge from Washington and what you can do to protect yourself.

To answer this question, we have to go back to 1974, before 401(k)s were invented. It was then that the Employee Retirement Income Security Act (ERISA), the primary law governing retirement plans, was enacted.

Its goal was to reform traditional pension plans, known as defined-benefit plans. To ensure diversification, ERISA mandated that no more than 10 percent of a plan's assets could be invested in company stock. Since that would have made profit-sharing plans that held company stock and employee stock-ownership plans (ESOPs) illegal, a compromise allowed those plans to continue.

"We didn't give it a second thought, since profit-sharing plans were merely supplementary at the time," says Michael S. Gordon, a pension attorney who helped write the ERISA bill. Then in 1978, pension consultant Ted Benna discovered the tax loophole that permitted the creation of 401(k)s, and since ERISA rules carried over to 401(k)s, company stock was allowed in those plans -- with no 10 percent limit.

Proponents of employee stock plans argue that they create wealth. "Many people have gotten very wealthy on company stock," says David Wray, president of the Profit Sharing/401(k) Council of America, a Chicago trade group of plan sponsors. "Employees want to be able to invest in their company."

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In reality, the evidence for wealth building is mixed at best. On average the typical 401(k) company stock delivers a return in line with the S&P 500's -- but at above-average risk. For every big gainer like Citigroup (up 94 percent over the past three years), there has been a disaster like Owens-Corning (down 95 percent).

But the benefits for company management are very clear. For starters, companies receive tax breaks for making contributions to 401(k)s, in either cash or stock, and a tax law change last year increased tax deductions on the dividends paid on company stock held in ESOPs.

That has prompted more employers that match contributions with company stock to create an ESOP within their 401(k)s; these hybrid plans are called KSOPs. For plan participants, the switch to a KSOP structure makes little difference -- you probably don't even know if you have one. But for a company that regularly pays dividends, the move can be a boost to earnings.

Even so, the financial considerations come second to strategic advantages. By placing company stock in a 401(k), employers ensure that the shares remain in friendly hands, which helps to discourage a hostile takeover.

The more money you have in any one stock, the more risk you face. Notes Benna: "At any point, a stock can easily drop 20 percent. And if it happens close to your retirement age, you will not have time to recover your losses."

Studies have shown that though overall market risk has stayed relatively constant, individual stock volatility -- which stems from company-specific events -- has more than doubled over the past 30 years.

And stock volatility is only part of the danger of owning company shares. You also have a huge investment in your company in the form of human capital -- the value of the income produced in a career. If your company runs into trouble, you can lose both your job and your prospects for retirement. Witness the workers hit by layoffs and 401(k) meltdowns at Lucent, Polaroid, Global Crossing, Motorola and Nortel.

If you're determined to bet on company stock, there's nothing to stop you from buying it on your own. (Many companies offer stock options and discount stock-purchase plans on top of 401(k) shares.) The real question is whether employer stock should be allowed in tax-subsidized retirement plans.

The sensible answer is no. "We heavily subsidize 401(k) plans for the express purpose of creating reliable retirement income for employees," says Gordon, the ERISA attorney. "If employees end up having to rely entirely on Social Security or welfare because they are allowed to gamble their retirements on company stock, that defeats the whole purpose of the tax privilege."

As for investor choice, let's get real -- when it comes to company stock, most participants are facing a stacked deck. Repeated studies have shown that investors don't understand the risk of owning company stock.

And they are not likely to hear bad news from management for two reasons: First, although employees may think that their interests are being protected by plan trustees, the fiduciary responsibilities of the trustees are not clearly spelled out by ERISA. Plus, the trustees have an inherent conflict of interest. As fiduciaries, they may want to warn plan participants about a problem, but as company officers, they may risk breaching their duty to other shareholders if they do so.

Far from explaining the dangers, most companies encourage their workers to invest in employer shares. When company stock is offered as a match, studies show, investors consider that an endorsement and put more of their money into it. Then there's human nature -- employees become emotionally attached to the stock. And that loyalty, says financial planner Michael McCarthy, a former benefits consultant with Hewitt Associates, leads them to be "overly confident about their financial prospects."

Since the Enron implosion, more than a dozen bills have been proposed or introduced in Congress seeking to address the issue of company stock in 401(k) plans. The best known, introduced by Democratic Senators Jon Corzine and Barbara Boxer, would prevent employees from holding more than 20 percent of their 401(k) assets in company stock, allow them to sell the company stock in their plans after 90 days, and trim employers' tax deduction if they contribute shares.

Pension experts say that the Boxer-Corzine bill has little chance of passage in the face of fierce opposition from business and 401(k) industry lobbyists. Lobbyists are even digging in against a milder proposal by President Bush to allow employees to sell company stock after three years. (See "401k reform: Don't hold your breath" for more.)

Defenders of the status quo argue that some companies may cut matching contributions or even drop their 401(k) plans if they can't get tax advantages for contributing stock. James Klein of the American Benefits Council, a Washington trade group, warns, "Companies may divert resources from 401(k) plans to broad-based stock-option programs" -- which are not included as financial obligations on balance sheets.

There are obvious rejoinders to this argument. For one thing, employers who cut back on matching contributions will have trouble competing for employees with companies that do offer them. Plus, matches are key to getting lower-paid employees to participate in 401(k)s. And if they don't participate, says St. John's University law professor Susan Stabile, "IRS nondiscrimination rules will limit the ability of higher-paid workers to contribute."

There's another incentive to reform: the growing number of class-action suits filed on behalf of employees alleging that keeping troubled company stock in their 401(k)s constituted a breach of fiduciary duty. Among the targets: Lucent, Nortel, Global Crossing, Providian and Ikon Office Solutions.

Many plan sponsors are now quietly discussing possible reforms to the company-stock rules in their 401(k)s, regardless of what happens in Washington. A few large companies -- including Gannett and International Paper -- have already announced changes that will allow participants to sell some or all of the matching employer shares in their 401(k)s immediately. Could the marketplace solve the problem before Congress does? That would be a remarkable example of capitalism at its best.