Attention, all 401(k) savers: Even though 75 percent of the 25 million eligible Americans are now savvy enough to invest in their company plans–up from 62 percent a decade ago–most employees aren’t revving up the account to its full savings potential. Consider these telling facts:
– About one out of every four 401(k) participants contributes less than 4 percent of his or her income to the retirement savings plan, rather than the 6 percent maximum most plans allow.
– Half of all contributors ages 31 to 45 say they take a conservative approach to investing their 401(k) money.
– One out of every five employees who own 401(k) accounts borrows from them–typically about $1,000.
– And half of all contributors spend as much as 50 percent of their balance when they leave their companies.
In each case, the four moves are financial blunders you can’t afford to make.
“In the early days of the 401(k), the primary concern was simply getting people to participate,” says Ted Benna, president of the 401(k) Association in Langhorn, Pa., an advocacy group. Now, continues Benna, who helped develop the 401(k) in 1980 and named it for Section 401 of the IRS code, the goal is “getting them to see the importance of using it as a savings plan for their retirement.”
To help you get your account movingh on the right track, a dozen leading investment advisers, benefits consultants and plan administrators were interviewed. Here’s their take on the four most common account mistakes and how you can avoid making them:
– Don’t postpone saving. For starters, contributing to a 401(k) reduces your taxable income, thereby putting cash in your pocket. Even better, employers in 60 percent of all 401(k) plans match investments with, typically, 50 cents on your dollar, sometimes dollar for dollar or even more. By not participating, you take a chance of passing up free money.
“People think it’s simpler to save when they’re older and have more disposable income,” says David Godofsky, an actuary with the benefits consulting firm of Bryan Pendleton Swats & McAllister in Nashville. “Truth is, it’s not.”
For instance, if you want to retire with a million bucks and you start at age 25, you have to save only $310 a month, assuming your investments earn an effective rate of 8 percent annually. However, if you wait until you’re 45, you’ll have to kick in $1,760 each month. And that’s at a time when you’re also likely to be saving for your children’s education as well as helping aging parents.
Furthermore, don’t wait for a higher salary to contribute the maximum your plan permits. “Most people should be investing about 6 to 8 percent starting in their 20s, in order to build a balance to replace about three-quarters of their income at retirement,” advises David Veeneman at Hewitt Associates, a Lincolnshire, Ill., benefits consulting firm.
– Take some investing risks. “Most of us,” says Veeneman, “confuse market volatility with gambling. We think if we put our money on the table and we don’t win right away, we’ve lost our wad.” The fact is, what goes down in the stock market usually comes back up within five to seven years. And the Standard & Poor’s 500 has historically returned about 10 percent long term–that is, since 1926. Stable bond funds, on the other hand, yield only 5 percent or so over the long term.
“You simply can’t accumulate wealth with a zero-risk philosophy,” adds Jim Klein of Towers Perrin, the New York City-based benefits consulting firm.
To secure a healthy yield of 8 percent a year, you should allocate 60 to 100 percent of your portfolio in stock funds, counsels Richard Glass of Investment Horizons in Pittsburgh and author of “Selecting Investments for Your Retirement Account” ($10.95; 800-466-2366). When you’re 10 years away from retirement, reduce your stock allocation to 50 percent or so of your portfolio. The balance of the money should be spread among fixed-income funds.
If you’re uneasy managing your own 401(k) portfolio, you may be tempted to invest in the newer life-cycle funds, currently available to about one in six 401(k) investors, according to Access Research, a Windsor, Conn., financial services consulting firm. But beware: Though these funds provide a ready-made mix of stocks and bonds geared to your age, they are sometimes too heavily invested in fixed incomes and their fees tend to be higher. An alternative is simply to put the majority of your portfolio in a large-cap stock fund and the balance in a bond fund.
– Don’t be so quick to borrow. More and more 401(K) participants are learning that borrowing from their accounts, rather than from a bank, nets them a lower interest rate and allows them to pay themselves back: 21 percent took a loan on a 401(k) in 1993, up from 15 percent in 1988.
There are drawbacks, though. First, when you take a loan from a 401(k), you could be depleting your account if the 401(k)’s loan interest rate is lower than your account’s rate of return. Plus, if you leave the company or are laid off in the five-year period before you pay back the loan (10 to 30 years if you use it to buy a primary residence), you must cough up the balance within 30 days or else pay federal income tax on the amount you still owe–as well as a 10 percent early-withdrawal penalty.
If you must borrow against a 401(k), do so only when your portfolio is earning less than you’d pay on your debt–say, 8 percent when bank loans are running at 20 percent.
That’s reckless. Spending that money will deplete your retirement savings. It will also make you liable to pay income tax and a 10 percent IRS penalty on every dollar you use.
Ultimately, pension plans can go bust and Social Security may yield no more than politics, but a 401(k) is yours alone. Stoke it well, and let it grow.
