Financial meltdown: 401(k) plans

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Biggest mistakes

As awful as it was for employees to see stomach-churning losses in their retirement plans during the height of the financial debacle, all things considered, 401(k) plans have fared quite well the past two years. The nation’s savings rate has increased month after month and some people have opted to put that extra savings into their retirement plans. On the negative side, 15 percent of employers have stopped matching employee contributions.

Fidelity Investments, which provides retirement savings plans for more than 17,500 companies, says the average account balance rose 13.5 percent to $53,900 during the second quarter of 2009. Additionally, more participants have increased their deferral amounts, reversing a recent trend of employees reducing the amount they deferred toward retirement savings.

Vanguard is another major administrator of defined contribution plans and says 19 percent of participants in its plans have increased their deferral rate, versus 9 percent who decreased them.

“With defined contribution plans, people need to get just two things right,” says Jean Young, a researcher in Vanguard’s Center for Retirement Research. “They need to save enough and they need to invest in an appropriate balanced strategy. On the savings front, when we look at the total savings rate — the employee’s savings rate and the employer’s contribution — the average contribution rate in 2008 was 10.4 percent. That’s pretty strong.”

Employees tend to make mistakes by age group, according to Fidelity.

An increasing number of workers in their 20s are participating in retirement plans, especially with the help of automatic enrollment. But the majority is still standing on the sidelines. Fidelity says that 56 percent of eligible workers in their 20s have not enrolled in their workplace plans.

Workers in their 30s and 40s are better savers — they enroll in plans and increase their contribution deferral rate — but they take out too many loans against their savings, and that can severely compromise their returns.

Folks in their 50s have gotten the message. They’re socking away the money and backing off from the loans, but they’re not doing a stellar job at asset allocation. Fidelity says 26 percent have either no exposure to equities or have 100 percent of their holdings in equities. Historically, having no equities means lower returns, while holding all equities leaves a participant vulnerable to a huge slide in the market, as we’ve just seen.

Despite the mistakes, the most important thing is to participate.

“The worst decision you could make would be to drop out altogether,” says David Wray, president of Profit Sharing/401k Council of America in Chicago. “The typical 401(k) participant is dollar-cost averaging into the rally, which is the absolute best time for an investor. Also, the typical participant has only been in their plan for about 10 years, so their account balance probably wasn’t all that high (before the crisis). So, the typical participant is actually almost ahead by now. Yes, there was a 25 percent reduction in their balance, but the new contributions and the rally have pretty much offset that for most people because their balances weren’t that high.”

Smart strategies going forward

If the financial crisis made you realize that your nest egg needs some serious work, consider some of the following tips, collected from various industry experts:

  • It’s best to plan for retirement rather than saying you’ll work for the rest of your life. The decision to work may not always be up to you. Health problems and other employment issues may force you out of the job market.
  • If you’re uncomfortable selecting among the investment choices in your company plan, ask your employer for assistance or consider showing the plan to a Certified Financial Planner. Talking to a professional will cost a bit, but down the line you may think of it as money well-spent. Also consider a target date fund that’s based on your age. It’s one of the easiest routes to proper allocation. It will automatically rebalance your account as the years go by, taking the account from more aggressive when you’re younger to more conservative as you near retirement.
  • Save, save, save. Make sure you have enough money to meet living expenses, but plan on saving diligently. Don’t think that because you’re 20 years old, you have plenty of time to save for retirement. Contribute as much as you can throughout your 20s and 30s for the best chance of retiring when and where you want.
  • Try to increase your deferral rate on a regular basis. If you’re contributing 2 percent one year, try to make it 3 percent the next year. If you’re significantly behind on your savings, you may need to scrimp elsewhere and boost your deferral into the double-digit realm.
  • Take advantage of company matches. Some companies match up to a certain percentage of employee contributions. Make sure you contribute enough to receive that benefit.
  • Don’t stop your contributions. Reduce them if you must during a crisis but stay in the savings habit. It’s too easy to stop contributions for a short time and then neglect to get them going again.
  • Steer clear of loans against your retirement plan if at all possible. Yes, you’ll be paying yourself interest as you repay the loan, but you will have lost significant earnings power while the money is out of your account. If you leave the company, you’ll be expected to repay the loan immediately.
  • If your employer doesn’t have a retirement plan, start your own. Open a traditional IRA and a Roth IRA at a bank or brokerage and try to maximize your contributions.

Need more information about retirement? Visit Bankrate’s Retirement center.

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