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Does your law firm have a good 401(k) plan? I don’t mean, “Are you saving enough through your firm’s plan?” Or “Have you chosen the right funds within the plan given your projected retirement needs and risk tolerance?” I mean, “Has your firm structured the plan in the best interests of its employees?” Not all plans are created equal. Yet many people think they’ve done all they can do by maxing out their contributions. They haven’t. Most lawyers and many law-firm administrators know very little about choosing a 401(k) plan’s range of investment options — typically a selection of mutual funds. The firm can seek outside help, of course, but for this kind of assistance, financial vendors may charge high fees, which often come at the expense of the employees in the plan. Blind trust in the merits of your firm’s 401(k) plan is not a good idea. As individual investors and business partners, lawyers need to take an active interest in the structure and management of the plan. Employees in other industries are already bringing a new wave of lawsuits over 401(k) plans. Last September, Northrop Grumman was sued over alleged violations of fiduciary duties in the administration of its plan. Defendants in other suits include Boeing, Caterpillar, and Kraft. In general, these suits allege that the 401(k) plans have excessively high fees in violation of fiduciary duties. Whether these suits succeed remains to be seen, of course, and they have not targeted law firms yet. But the claims have attracted considerable attention, and astute firms should appreciate a way to deter such allegations. If 401(k) reforms would also improve the retirement prospects for employees, so much the better. Fortunately, there is a simple solution. One large plan, serving about 3.5 million people, provides a solid model upon which law firms can base their own 401(k) plans. Its design should help participants obtain sound investment results, and its strong reputation should deter accusations of impropriety. Some consultants might charge hefty fees to craft a 401(k) plan with such desirable characteristics. But this model has already been developed, implemented, and tested at public expense. It’s the Thrift Savings Plan, the equivalent of a 401(k) plan for federal government employees. THE MARKET PLAN Like a 401(k) plan, the TSP lets employees have pre-tax money deducted directly from their paychecks and invested for retirement. The government plan offers three stock funds and two bond funds. The stock funds are dubbed the C Fund, which invests in large U.S. companies; the S Fund, which invests in small and medium-sized U.S. companies; and the I Fund, which invests in international companies in the developed world (including Western Europe, Japan, and Australia). The bond funds are named the F Fund, which buys a broad range of corporate and government bonds, and the G Fund, which invests in special government securities that provide returns similar to those of long-term Treasury bonds but without any risk of loss of principal. With the exception of the G Fund, all of these choices are index funds. That is, the funds own a wide range of securities in an effort to track the overall returns of a certain asset class. By contrast, most mutual funds attempt to achieve higher returns by selecting individual stocks or bonds that a manager thinks will outperform the market. History shows that over the long term, almost all stock and bond pickers underperform the market index. Expenses for the TSP funds are rock-bottom. As of Dec. 31, 2005, the two bond funds had expenses of 0.04 percent of assets invested, and the three stock funds had expenses of 0.05 percent. By comparison, the average mutual fund had expenses in 2005 of 1.5 percent — 30 times as much. For government employees sophisticated enough to design their own portfolios, these five TSP funds are excellent tools. (As a former government lawyer, I’m still invested in the TSP.) But for those who are not as knowledgeable, the TSP in 2005 began offering an easy-to-use alternative: life-cycle funds. These funds, called L Funds, offer packages of the other TSP funds with asset allocations based upon the employee’s projected time until retirement. For example, the L 2040 (for someone planning to retire in 35 years) provides a more aggressive portfolio — 85 percent in stocks in 2005 — whereas the L 2030 (for someone 25 years from retirement) follows a slightly less aggressive strategy — 75 percent in stocks in 2005). On the other hand, for someone who is just about to retire (or is retired), the L Income is far more conservative — close to 80 percent in bonds. Bonds are typically viewed as less risky than stocks and thus more appropriate for older investors who lack the time to wait out a market downturn. As the investor moves closer to retirement, the L 2040, L 2030, etc., will automatically adjust the asset allocation to replace stocks with bonds, thus becoming more conservative. The portfolio composition of the L Funds follows the conventional advice that those with a long time to invest should put most of their money in stocks. If future stock returns turn out to be as high as past stock returns (which, I stress, is by no means certain), investors who put their retirement money into the relevant L Fund will likely do better than if they put most of their money into the G Fund. WHAT WORKS Although private employers cannot invest in the TSP’s funds, they can duplicate its key advantages in designing their own 401(k) plans. Perhaps most important, the TSP allows investors to capture the market return from a variety of asset classes at minimal cost. Keeping investment costs low is critical. The less investors spend on costs, the more they have for themselves, whereas high costs, over the long term, will almost certainly consign a portfolio to inferior performance. Happily, law firms designing retirement plans can actually do something about costs. The future returns of a mutual fund obviously are not controlled by investors’ wishes, but plan designers can realistically choose to find low-fee funds for employees. Frequently, these low-fee mutual funds will be index funds. Indexed investments hold only about 9 percent of the total assets managed by investment companies, yet their presence in a 401(k) plan is a boon. Over the period of 30 years or so that most people save for retirement, almost all mutual-fund managers will fail to consistently beat the relevant market index. Abandoning active management with its higher fees and ever-present risk of lagging the market will likely provide better returns for fund participants. Finally, life-cycle funds represent a relatively straightforward option for unsophisticated investors. Alas, many people find personal finance intimidating and dull — at social gatherings, I try to restrain my enthusiasm for the subject — and, unfortunately, financial sales people lie in wait to exploit the uninformed. Life-cycle funds are the opposite of exciting. But left to less scrupulous advisers, many investors could easily do much, much worse. In addition, if these lawsuits over 401(k) plans alleging breaches of fiduciary duties take off, I suspect that plans modeled after the TSP will be at the very bottom of the target list, and allegations of abuse — at least as to the structure of the plan — will be easily repulsed. Low fees, index funds, and balanced portfolios are all signs of investment honesty and competence. And it will be a tough sell to argue that it’s improper to mimic what the federal government provides its own employees. Low-cost funds, superior long-term returns, and easily defensible if challenged — that’s an attractive package. Law firms could do much worse than to adopt it as their own.
Robert L. Rogers, associate opinion editor at Legal Times , writes the Legal Tender column on personal finance. E-mail Rob with comments or suggestions for future columns.

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