Love Your Job, but Don’t Put All Your Retirement Eggs in One Basket

Alamy Your employer provides you with a salary, and probably some benefits as well. If you’re lucky, your company may even chip in a bit to help you with your retirement plan, potentially with a 401(k) match or some other form of investment on your behalf.

The old saying “Don’t look a gift horse in the mouth” holds true here — make sure you get every penny of the money your employer is offering to give you for your retirement.

Still, you want to understand the form that “gift” takes and the risks associated with it. You may find that your employer’s contribution could be more risky than it seems on the surface, especially if it comes in the form of company stock.

The Risks of Owning Too Much of Your Employer’s Stock

Owning stocks can be a wonderful way to invest for your retirement. Indeed, any retirement savings plan that does not include stocks is one that will likely have trouble keeping up with long-term inflation, especially if interest rates remain stubbornly low.

But your employer’s stock is an entirely different beast.

The key reason is simple: If the company runs into trouble, you could find yourself not only out of a job, but also out of a substantial part of your retirement savings. Since time is such a critical part of any retirement plan, the compounding time you lose if your employer implodes while you’re overinvested in it could be as big a problem as the actual dollars you’re out.

Remember Enron? Until it imploded, Enron seemed like a great place to work — even being named to Fortune’s list of “100 Best Companies to Work for in America.” And its stock, for a while was soaring to around $90 a share.

At the time the company crumbled, around 62 percent of the assets in its 401(k) plan were in company stock, and the employer match came in the form of Enron stock that couldn’t be sold until the employee was 50. Sixteen months after Enron’s shares peaked, its employees were unemployed and those shares had a value of, essentially, zero.

While not every company will turn out to be Enron, every Enron employee — even the ones doing legitimate work — saw the money they had invested in the company’s stock vanish. That put a serious dent in their retirement plans at the exact same time that they were put out of work as a result of the company executives’ deceit.

Even when a company fails for less deceptive reasons — like Circuit City, Washington Mutual, or even a company like General Motors(GM), which can be reborn and revitalized through bankruptcy — when a company’s stock becomes worthless, overinvested employees lose big-time.

What You Can Do About It

If you can diversify within your 401(k), do so. Of course, don’t turn down any free money you can get for investing in your 401(k) — even if that money comes in the form of company stock. But beyond that, seriously consider putting your own contributions in other options within the plan. Also, find out the options available to you for moving the company contribution into something else.

If you can’t diversify within the plan, ask your HR manager if “in service distributions” are available. If they are available and you qualify, you may want to consider using an in service distribution to directly roll your company stock holdings from your 401(k) into an IRA. Once those holdings are in your IRA, you can diversify as you wish.

If neither of those options are available, every time you look at your retirement plan, run the numbers — twice. For the first run, consider what happens if the company remains healthy. For the second, consider what happens if the company runs into serious trouble that costs you your job and your investment.

Manage your overall retirement plan as if the second scenario is the likely outcome. That way, if the worst comes to pass, you’ll still be OK. And if your employer remains strong, you can buy yourself an early retirement.

The Downsides of Pessimism

Of course, there are a few reasons you may want to consider holding on to company stock in your 401(k) rather than diversifying, especially if diversifying means taking the money out of the 401(k):

No. 1: Distribution tax savings. Company stock held in a 401(k) can be withdrawn via a special “Net Unrealized Appreciation” transaction that can reduce the tax bite versus standard 401(k) withdrawals. (More on that here.)

No. 2: Dividend tax penalty savings. If the company stock held in the 401(k) is classified as an ESOP (Employee Stock Ownership Plan) and the company pays dividends, you can get those dividends paid directly to you without the standard 10 percent penalty on early withdrawals from retirement accounts.

No. 3: Earlier distribution options. If you plan to work at your employer until at least age 55, you can take money out of your 401(k) without paying the 10 percent penalty for early withdrawals. If you have to roll the stock into an IRA in order to diversify, you have to wait until at least age 59½ to withdraw the money without penalty.

No. 4: Lawsuit and bankruptcy protection. While state laws protecting IRAs vary, federal law protects employer-sponsored 401(k) plans from being emptied by most lawsuits or creditor judgements.

Be Reasonable

Of course, if your employer turns out to be the next Starbucks (SBUX) or Google (GOOG) instead of the next Enron, you may look back and wish you had invested more. In reality, there’s nothing wrong with holding some of your employer’s stock if you really believe in its long-term future. Just don’t bet your retirement on it. The damage to your future if your employer implodes with you owning too much stock can be devastating.

Motley Fool contributing writer Chuck Saletta has no position in any stocks mentioned. The Motley Fool recommends General Motors, Google, and Starbucks. The Motley Fool owns shares of Google and Starbucks. Try any of our newsletter services free for 30 days.

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