Financial Literacy 2007 - Retirement
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Retirement planning with a 401(k)

2. Fund up to the limit.

The amount of money you can put into a 401(k) is set by law, although it has been increasing. Currently, individuals can save up to $15,500 in pretax dollars, and anyone 50 or older can stash up to $20,500 in 2007.

Today, many earners fall far short of those limits. In fact, just over a third of individuals who do save in a 401(k) put in just enough to trigger a full employer match, according to Hewitt Associates.

If the maximum seems too rich for your budget, then work toward it methodically.

"Acclimate yourself to saving," says Dee Lee, a Certified Financial Planner and author of "Women & Money." "It's like working out. If you go in and try to do it all in one day, you'll be so tired you'll never do it again. But if you do a bit everyday, you'll be able to do more. Saving in increments won't hurt, especially if you're new to it. And, over time, success breeds success. You'll find that saving money can be addictive."

3. Be careful of going on savings autopilot.

It's become so important for people to save for retirement that many employers have begun to introduce automatic features to 401(k) plans. Prodded by a 2006 change in the federal law, more employers are automatically enrolling workers in 401(k)s, who must then make an effort to opt out of the program. Others trigger annual contribution increases of 1 percent or link them to pay raises. And still other plans choose investments so your money is invested on your behalf.

This is all very well and good, but your company shouldn't have to play the parent. After all, while mom and dad have had your best interests at heart, they may not have always made the right decision for you. So, too, with automatic 401(k) plans. Yes, they're getting workers to save. But there's a downside for those who let their employers do their retirement planning for them.

"If a person is automatically enrolled, they tend to just go with the program. They don't contribute enough. You want to make sure you qualify for the full match," says David Wray, executive director of the PSCA.  

Plans that automatically enroll wage-earners generally divert 3 percent of their salary into the 401(k), says Wray. There's only one problem. On average, employers require individuals to save 6 percent of their salary before matching contributions kick in. So you may be automatically enrolled, but you could still be missing out on those company contributions.

What's more, workers who make the effort to sign up for a 401(k) tend to be more aggressive with how they invest their earnings. Just over four out of 10 employers with automatic enrollment invested the employee's savings in stable value or money market funds -- investments that don't have the growth potential of other equity funds, according to Hewitt Associates.

While it may be reassuring to know your plan isn't taking risks with your money, it's a big mistake to assume safety comes without pitfalls. So make the effort to boost contributions and select investments based on your personal retirement goals.

4. Don't let a new job torpedo your old 401(k).

It's ironic. Workers often leave jobs to move to more profitable pastures. But when they do, their retirement savings take a big hit. According to Hewitt Associates, a whopping 45 percent of workers leaving their jobs cash out of their 401(k) plans.

That's a very expensive mistake. Here's why: Taking distributions from a 401(k) plan is not like tapping into a savings account. That's because you'll owe a 10 percent early withdrawal penalty if you're younger than 59½, plus income taxes on the entire amount. Instead of squandering those savings, have the assets directly rolled into an IRA, where earnings can keep growing tax-deferred.

Oops. You didn't roll over into an IRA? It's not a lost cause.

You can still move 401(k) assets into an IRA but you have to move fast-- within 60 days -- and it will cost you. That's because your former employer will automatically withhold 20 percent of assets when your 401(k) is cashed out. You must replace those when you fund your new IRA. But if you do manage to open a rollover account by the deadline, the 20 percent withholding that you replaced out-of-pocket will be reflected in your tax return, and you'll wind out coming out even.

"It will be reflected like a wage withholding. Therefore, because that 20 percent was withheld, it will reduce the amount you owe or entitle you to a greater refund," says Mark Luscombe, principal tax analyst at tax law publisher CCH.

5. Diversify. Diversify. Diversify.

Financial experts agree that the best way to hedge against risk is to diversify so that you own a variety of stocks and bonds. That means paying attention to funds -- and company stock -- that may be in your plan.

"Asset allocation is the most important thing," says Dick Bellmer, chairman of the National Association of Personal Financial Advisors.

That's a message more employees need to take to heart. These days, plans boast on average 19 funds, according to PSCA. But that doesn't mean workers are necessarily spreading their risk. According to Hewitt Associates, workers generally invest 401(k)s in four asset classes.

One easy way to ensure that your investments are diversified is by investing in lifestyle funds, which automatically adjust holdings depending on age and retirement goals. Planners recommend them as a great way to get started, especially for younger workers who need help picking investments. However, as you approach retirement, you'll need to tailor your investments to your personal goals.

And tread lightly if your company contributes matching funds exclusively in their stock, or if your shares have gone up. Those investments could quickly make up a good chunk of your 401(k) balance. And if that's the case you're at greater risk of watching your savings evaporate, should that single stock drop in value. So what's the ideal limit?

"Personally, I like to see no more than 5 percent," says Bellmer.

Many workers need to take this limit to heart. On average, company stock makes up 24 percent of 401(k) balances, according to PSCA.


If you want to rebalance your shares, there's good news. It's becoming easier to diversify. Employers may make you wait a certain period of time to do so, but 46 percent of plans that make matching contributions exclusively in company stock let employees diversify those shares at any time. That's up from the 15 percent who did so back in 2001, according to Hewitt.

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