For average earners, the 401(k) savings plan has special benefits. Tax-deferred pool allows contributions by employer; holder may borrow funds

Uncle Sam has not offered much to the little guy with all the tax reform that's hit the boards in the last few years. Most of the new benefits went to businesses and income earners in the higher brackets. The exception, however, is an item called the 401(k), or salary savings plan, an important part of pre-Reagan tax reform. The 401(k), when set up by an employer, allows employees to contribute a portion of their paychecks to an investment pool and defer taxes on these contributions as well as the earnings on them. A 401(k) works much like an IRA, but with a few extra perks. The money can be borrowed by the employee; it can be income-averaged for 10 years when cashed out at retirement; and employers can match employee contributions, using the fund as a less expensive profit-sharing or pension fund.

``These things have been received with enormous enthusiasm,'' comments one tax and investment adviser, ``not only because they are a good deal, but because people are getting the message that social security probably won't be there when they are ready to retire. They see the 401(k), and quite rightly, as a relatively painless and much more lucrative way to fill the gap that will be left by social security.''

The Treasury Department's tax simplification plan, however, has proposed eliminating the 401(k). The department argues that the IRA is a more ``appropriate vehicle'' for deductible retirement contributions. The only people who can have a 401(k), the Treasury notes, are those whose employers have offered them, whereas IRAs are available to everyone ``without regard to form of employment or occupation.''

Proponents of the 401(k) contend, however, that participation rates among people offered a 401(k) are much higher than the rate for IRAs. In part, this is because of matching contributions made by employers, more accessible information and answers to employees' questions, and the ease of making contributions through payroll deduction plans.

Initially, 401(k)s struck a sweet spot primarily with large corporations, such as those in the Fortune 1,000, says Jerry Marrs, who heads the tax department at Arthur Young & Co.'s Denver office. ``Now, though, we're seeing a lot of interest from smaller corporations. There's been no letup in interest that I've seen. If anything, they've become more popular as more companies learn about them. If it's any indication of the popularity, Arthur Young has set up a plan for its employees.''

As they rush to the 401(k) trough, however, companies need to understand that, like most good things, especially from Uncle Sam, there are a few trade-offs, one or two strings attached. Unless it is well planned, a 401(k) can add considerably to a company's administrative burdens. The IRS sets strict discrimination standards designed to prevent the higher-paid one-third of employees from contributing proportionately more than the lower-paid two-thirds, and those standards have to be maintained scrupulously.

David Jack, senior consultant with Butcher & Singer's Fiduciary Consulting Group in Pittsburgh, also explains that a 401(k) fund cannot be handled like a traditional pension or profit-sharing fund. ``Basically,'' he says, ``one of the big problems is that you're starting out with no money in the fund. The kind of individual money manager who can do the best job generally requires a minimum of $1 million and often up to $20 and $30 million. So right off, most 401(k)s are eliminated from a large portion of the best money managers.''

Instead, they usually turn to trust departments at banks or, more often, a mutual fund to safeguard the investments of employees. Those choices, however, require special considerations, Mr. Jack says. A mutual fund manager, in particular, should offer a depth of investment options. A narrow investment philosophy, such as buying stocks only in emerging growth companies, can fall out of favor with the market and leave employees with no alternative. The cost of switching managers can be considerable for the sponsoring company.

Another problem, says Jack, comes from giving relatively unsophisticated investors -- the rank and file within a company -- some relatively sophisticated investment decisions. A mutual fund family, for example, may offer funds ranging from conservative, fixed-income investments, such as insurance contracts, to aggressive funds that seek rapid appreciation but carry higher degrees of risk. Unless that level of risk is explained, an investor might be attracted by the potential for appreciation but become disappointed as the investment follows the market as it twists and turns between bull and bear.

Pension fund investments, by contrast, ``have a long-term horizon,'' says Jack. ``The fund manager reports to an investment committee generally made up of the top executives in the company. They understand the investments and the fact that the money is being invested for the long haul. With a 401(k), the investors are, for the most part, relatively unsophisticated people who have a very short-term horizon. That leads to much more conservative investments.''

Companies should consider that if their employees borrow their money back out of the 401(k) when their portfolio is down, they may never make up that loss.

``There's a lot to be said for overcommunication,'' explains Anthony Russo, director of retirement planning at Lord, Abbett & Co. in New York. ``One school of thought is that the less said the better. Out of sight, out of mind. The other school of thought, and the way we like to work a 401(k), is the more said, the better. It's the employee's money, and we want to have the employee involved. Otherwise they start to worry.''

Lord, Abbett manages seven mutual funds and offers six of them to companies with 401(k) plans. Mr. Russo says the executives in a company generally invest in the more aggressive funds, and the rank and file favor the more conservative.

He adds that companies will let employees switch funds as often as every quarter. ``As far as extra paper work involved in making switches, it really doesn't affect the company, since we keep all the records for free.''