Help! My company cut my 401(k) match

If your employer was one of the growing number of companies to suspend or reduce its matching contribution, here's what to do.

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By Walter Updegrave, Money Magazine senior editor

Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

NEW YORK (Money) -- Question: My company has suspended matching contributions in my 401(k). I'm unsure what to do, but I'm thinking of rolling my 401(k) into an IRA account. Is that a good idea? --Brian, Taylor, Michigan

Answer: For what it's worth, you're not alone. As a way to reduce expenses in the face of this economic slump, a number of companies, including FedEx, GM and Motorola, have either eliminated or reduced matching contributions to their 401(k) plans recently.

This sort of cutback would be a drag anytime, but it's especially bothersome now given that many people need every cent of savings they can get to rebuild 401(k) balances that have plummeted by 20% or more over the past year.

But the remedy you suggest - rolling your 401(k) into an IRA - really wouldn't be much help. For one thing, if you're still working for your company, such a move probably isn't even possible. You can't just willy-nilly roll money from your 401(k) to an IRA. You must be eligible to do a rollover, which for the most part means you must either be retiring or leaving your company for some other reason, such as a layoff or job switch.

And even if you could do it, rolling the money out of your 401(k) into an IRA wouldn't solve your underlying problem, which is that less money is now going toward your retirement nest egg. It's not as if the act of moving your savings from a 401(k) to an IRA will somehow boost the amount of money you have. And the investment firm or mutual fund company you would choose to manage your IRA account certainly isn't going to kick in any matching contributions.

So what should you do if your employer has already axed or trimmed your match or if your company joins the growing ranks of firms that have?

Well, at the very least you should continue contributing however much you have been to the plan. I've gotten emails from some people who are considering halting their contributions and investing outside their plan. But that makes little sense to me. You would be giving up a valuable tax benefit in that you invest pre-tax dollars in a 401(k) and any investment gains compound free of taxes until withdrawal. And you would also forego automatic payroll deductions, which assure that your money actually gets saved and invested.

If possible, though, I think you ought to go a step farther - namely, boost your own contributions to the extent possible to compensate for the dropped or reduced match. Otherwise, you'll be looking at a downsized nest egg come retirement time.

How much smaller will depend on the size of the match and length of time before it's reinstated (assuming it is). But here's an example. Let's say that you're 40 years old, earning $60,000 a year and that your company had been providing a fairly typical match of 50 cents on the dollar for the first 6% of salary you contribute. If the company suspends that match for five years, then even assuming no pay raises, you would be losing matching funds of $9,000, or $1,800 a year.

That may not sound like a princely sum, but remember: you're also losing any earnings those matching funds would have generated while sitting in your account. Assume a 7% annual rate of return, and your 401(k) account would be roughly $40,000 smaller at age 65 than it would have been with the matching funds. Of course, the larger the match and the longer you go without it, the bigger the impact.

Ideally, you would want to make up for the suspended match by simply making more regular pre-tax contributions to your 401(k). That's the simplest solution. But if you're already on target to make the maximum contribution - the legal limit is $16,500 for 2009, plus an extra $5,500 if you're 50 or older (although your plan may set a lower ceiling) - then you may have to make up for the shortfall by socking away money elsewhere.

If you're eligible, you can fund either a traditional or Roth IRA. If not, you might consider funding a nondeductible IRA (which, no matter how high your income, you would have the option of converting to a Roth next year). Or you could consider contributing after-tax dollars to your 401(k) (assuming your plan allows this) or simply investing in tax-efficient index funds or tax-managed funds in a taxable account.

In tough times like these, naturally, you want to be especially sure that you have sufficient cash reserves to weather a layoff or other financial setback. So before you begin picking up the slack for a shrinking match, make sure you have three to six months' worth of living expenses tucked away in a secure stash like a savings account, short-term CDs or a high-quality money market fund.

One final course of action would be to look for a new job that offers comparable or better pay plus a 401(k) with a match. But given the pace at which firms are laying off people these days - the latest Bureau of Labor statistics employment report showed that companies shed 524,000 jobs in December - switching positions may be tough.

The point is, though, you want to do whatever you can to mitigate the effect of a downsized company match. Otherwise, you may be forced to downsize your retirement lifestyle as well. To top of page

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