In 1978, Congress decided that Americans needed a bit of encouragement to save more money for retirement. They thought that if they gave people a way to save for retirement while at the same time lowering their state and federal taxes, they might just take advantage of it. The Tax Reform Act was passed. Part of it authorized the creation of a tax-deferred savings plan for employees. The plan got its name from its section number and paragraph in the Internal Revenue Code -- section 401, paragraph (k).
­Ted Benna, who was a benefits consultant, actually came up with the first version of this plan. His plan was officially accepted by the IRS and proposed regulations were issued in 1981. In 1982, taxpayers were able to take advantage of this new plan for the first time. It took almost 10 years, but final regulations were eventually published in 1991.­
When people talk about 401(k) plans, you often hear about advantages like:

• Free money from your employer
• Lower taxable income
• Savings and earnings that accumulate without you having to remember to make deposits
• The opportunity to retire and not have to worry about money anymore

­Does this sound too good to be true? It isn't. It's what you can gain from investing in your company's 401(k) plan. The 401(k) is one of the most popular retirement plans around.

Is the 401(k) Plan Really Worth it?

A recent study shows a change in the way that companies are approaching 401(k) plans. The typical 401(k) plan is set up to where employers will provide a $0.50 on the dollar or a dollar for dollar match to any contributions by the employee. Well, things have changed since the start of the credit crisis and recession. Similar to most recessions, employers will suspend the employer matching contributions program until the economy starts to rebound. This time 401(k) consultants say there is a different response. Consultants are reporting that their clients are either stopping the matching program altogether or making the match available to employees only on the basis of profitability of the company. In other words, if the company makes money, then the employee gets the match. This credit crisis has really made employers rethink the matching contributions program. Does it make sense to keep investing money into a 401(k) plan? If your 401(k) plan doesn't have a match, I would argue that it makes no sense to continue investing into it. The employer match (or free money as I like to call it) is the biggest benefit of a 401(k) plan. Beyond that, there are more cons than pros to a 401(k) plan. 1) Lack of investment choice - Most 401(k) plans do not have enough choices for investment. I have looked at 401(k) plans with as little as 5 investment funds available for investment. That is clearly not enough diversity. Even if the plans have plenty of funds, they don't have enough different types of funds. They might have 10 stock funds and 4 bond funds. As we saw last year, bonds and stocks can both lose money at the same time. 2) Lack of secure investments - Most 401(k) plans at least have a money market; however, some do not. Last year I looked at plenty of 401(k) plans that literally had no safe place for the participant to put their money. 3) High expenses - When it comes to expenses, you don't have a choice. You are stuck with those high built-in 401(k) plan expenses. With 401(k) plans, there are a lot of people who are to be paid something. That is all built into the hidden expense ratio. There has been a lot of talk coming out of Congress to force better disclosure of these expenses. What is the alternative? If possible, max out an IRA or a Roth IRA. Yes, the only other advantage to a 401(k) plan is the tax deduction and you will forgo the majority of the tax benefit if you are maxing out the 401(k) plan. However, with an IRA you can still get at least $5,000 (and depending on your age, up to $6,000) in tax deductions. Those limits will increase down the road as well. As a rule of thumb, I don't recommend basing your investment decisions on tax savings. What if you were investing more than $5,000 or $6,000? You would then consider opening up an investment account and saving into that account with the additional money. Having money in a taxable investment account can be a very prudent way to save. You have two other advantages with an IRA as your retirement vehicle of choice. First, you have at your disposal a selection of all of the categories of investments available on the market. You can also control expenses more effectively with an outside plan based on the investments that you choose. Most importantly, you can have your IRA managed for risk and growth. That is a big deal. The best you can hope for with a 401(k) plan is a buy and hold strategy which has proven to be fatal for your account values.