How To Boost Your 401(k) Account
Pension Plans Fading; Small savings increases can have biggest impact in retirement nest egg.
Traditional pension plans are not totally dead and buried. But big corporations keep building the coffin.
The latest nail was hammered home Jan. 5. IBM announced a freeze on its $48 billion plan for U.S. workers.
Big Blue also said it would boost 401(k) plan benefits for its 125,000 domestic employees.
IBM's move was a reminder that Americans are increasingly responsible for building their own retirement nest eggs.
There are four sources of retirement income, says Stuart Ritter, a T. Rowe Price financial planner.
Two of them -- Social Security and pension benefits -- are looking less reliable. That leaves post-retirement work and personal savings.
"The source you control most is personal savings," Ritter said. "Some people can get demoralized by the shrinking of the first two sources. But the key to helping yourself is to not get so discouraged that you do nothing."
And the No. 1 self-help step: Save more.
Estimates of how much income you'll need in retirement typically range from 75% to 100% of your income in your peak paycheck years.
The Internet is awash with calculators that help you figure out how large your nest egg must be in order to generate a given amount of yearly income.
At their current savings rate, a lot of workers are not on track to set aside as much as they'll need.
Still, you don't need the skyscraper annual returns many tech-heavy funds earned in the late 1990s to make up the difference.
"What's surprising is how big a difference small increases in contributions to a 401(k) plan can make," said Peter Kapinos, a Putnam senior vice president for retirement plans.
Small Steps Add Up
A recent Putnam study found that even small increases in your deposits can help a lot.
Findings were based on investment performance for various asset categories from 1990 to 2004.
It made five assumptions for a hypothetical worker, whose starting salary is $40,000:
** Company match of 50%.
** Conservative mix of investments. His portfolio holds 60% U.S. bond funds, 25% U.S. stock funds, 5% foreign stock funds and 10% cash.
** 3% annual pay raises.
** 2% annual contribution rate, before company match.
** His account starts out with funds whose performance over the previous three years ranked in the bottom 25% of their Lipper categories.
After 15 years his balance would be $39,700.
And what happens if he shifts to top quartile funds from his bottom quartile holdings, then readjusts to the new top quartile every three years? Not much.
His end balance rises a mere $445, according to the Putnam study.
What if he uses a more growth-oriented portfolio?
Say his mix, from the start, is 65% U.S. stock funds, 20% foreign stock funds and 15% bond funds.
Then his end balance increases by $8,500 to $48,200.
By far, the biggest benefit comes from the simplest action: boosting his annual contribution.
If he doubles his yearly deferral to 4% from the beginning, his balance after 15 years is $79,400.
That's a gain of $39,700, even if he starts and sticks with his bottom quartile conservative mix of funds.
If in addition he uses the growth-oriented portfolio, he gains another $8,500 for a total of $87,900.
So boosting your annual contribution can be a key step.
And hiking the amount you kick in can be simple.
Say your deferral rate happens to be low, and you're not sure you can afford a big increase all at once.
Just increase it by one or two percentage points yearly until you hit the maximum allowed.
Also, many plans let you order annual increases in advance. If your plan does, that can put increases on autopilot.
And there are other ways to take any pain out of bigger deferrals.
"If you get a pay raise, it's often around the first of the year," Ritter said. "So if you set aside all or part of the raise, the paycheck you're used to receiving won't actually get smaller much if any."
Test Drive
A test increase is another way to make a bigger deferral hurt less.
For instance, perhaps you're afraid you can't afford to lose more from your paycheck. You've resisted a bigger contribution because it seems so permanent.
"If your plan lets you, increase your increase by just a percentage point or two for just three months," Ritter said.
"If you really can't afford it, switch back. But people often find that the rest of their budget adjusts. It turns out they're fine making a larger contribution," he said.
Whatever type of investments you choose, stick to your strategy.
"Look at whether you need to rebalance once a year," Kapinos said.
If one category of funds, for example, has greatly outperformed your others, but your overall plan hasn't changed, shift your allocation of new money going forward.
By Paul Katzeff
Investor’s Business Daily
