Enron is the Houston, Texas energy giant that collapsed a few months ago. And with it, the retirement security of many of its employees collapsed.

So now people ask what is a 401(k) and how can they avoid the Enron problem.

A 401(k), the fastest growing retirement plan, is a qualified plan companies adopt for employees. Some of its terms are mandated by law, and some are at the discretion of the employer.

The tax advantages of a qualified plan are the employer gets a deduction for its contribution and the employee delays reporting income until she makes a withdrawal. An employee who puts part of her paycheck into the plan delays reporting this part as income until she makes a withdrawal.

The 401(k), which gets its name from the number of the Tax Code section that created it, is a contribution plan. A participant receives on retirement what he and his employer contribute to his account plus earnings minus losses.

A sage once called the 401(k) one great invention of modern capitalism. Translated, that means opportunity and risk. When you invest in capitalism, you may become rich or go broke. Unless you are fabulously wealthy-and even if you are-you should hedge your bet, i.e., diversify your investments. The average plan provides the participant a choice of 13 investments including money market funds, company stock, fixed-income insurance securities and real estate investment trusts.

In Enron's 401(k), the plan offered employees several options for their contribution. They could choose one or more of the investment funds or company stock. Many chose Enron stock. Why not, the value was soaring-at the time.

For those who put their contribution into Enron stock, their retirement savings evaporated as the stock price fell. Everything was fine in August 2000 when the stock was $90 a share. But by November 2001, it had plunged to 29 cents. The company had matched the employee's contribution with its own stock. This became almost worthless, as did the employee's contribution invested in Enron stock.(more at Retirement Planning)

THE MORAL: Diversify, diversify, diversify.

Released 4-1-02