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Editor's note: This article is adapted from Kiplinger's Retirement Planning 2008 guide. Order your copy today.
Retirement savings plans are undergoing an extreme makeover. After decades of trying to teach Americans how to save and invest for their own retirement -- with mixed success -- employers have come up with a simple solution: They'll do it for you.
Thanks to automatic enrollment in 401(k)s and other retirement plans, plus streamlined investment options, saving is so effortless that you can't help but succeed. And that's true whether you're starting your career, switching jobs or planning your exit.
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To help their employees compensate for disappearing pensions and declining Social Security benefits, 44% of large companies have already embraced the new reality of retirement saving: the automatic 401(k). That's up from just 36% in 2007. More than half of all employers expect to offer automatic enrollment this year. The trend also applies to 403(b) retirement plans for teachers and employees of nonprofit organizations, as well as to the 457 plans that many state and local governments use. "Now you'll succeed at saving for retirement even if you don't do anything," says Jeff Maggioncalda, president of Financial Engines, a pioneer in providing investment advice to workers.
The most effective new plans pair automatic enrollment with an option to increase the amount you contribute to your account each year. When Nationwide Insurance added an automatic-escalation feature to its 401(k) plan last year, employees Sean and Lisa Kennedy signed up, promising to boost their contributions by one percentage point each year until they reach the maximum contribution level. "We can tie it to our annual salary increases," says Sean, 38. "We'll never see the extra money in our take-home pay, so we won't miss it."
Aside from adding to their already substantial nest egg, the Kennedys will also be able to cut their taxes -- a more immediate concern, says Lisa, 31. She and Sean, who live in Columbus, Ohio, plan to contribute at least $28,000 to their retirement accounts in 2008, saving them about $8,400 in taxes, assuming a combined state and federal rate of 30%.
The third piece of the automatic 401(k) model is built-in professional investment advice, whether in the form of target-date retirement funds, computer-generated model portfolios or managed accounts. Together, the changes amount to a total overhaul of 401(k) plans. "It reverses our assumptions about what individuals are willing and able to do," says Maggioncalda. "It makes inertia work in their favor."
Simple Way #1: Don't Opt Out
Employees are nearly unanimous in their support for being automatically enrolled in their company's 401(k) plan, according to a recent study conducted for the Retirement Made Simpler coalition, made up of AARP, the Financial Industry Regulatory Authority (Finra) and the Retirement Security Project. Nearly 95% of surveyed adults agreed that automatic 401(k) plans make saving for retirement easier, and 85% said they started saving earlier as a result. Only 7% of those who had been automatically enrolled in a plan opted out. (If you are automatically enrolled in your company plan, you can get your money back without tax penalty if you back out within the first 90 days.)
Although auto 401(k) plans are a major step forward, they have a downside. Pamela Hess, director of research for consulting firm Hewitt Associates, worries that some employees may be lulled into complacency, accepting default contribution levels as implicit savings guidelines when they can and should be saving more. Most employers set the initial deferral rate at 3% of salary, and many plans with automatic-escalation features top out at 6% of pay. That's well below the 15% of gross income (including employer matching contributions) generally recommended as a target for retirement savings.
The Kennedys, who are approaching that recommended 15% target, are well on their way to a secure retirement, even if their plans to start a family force them to scale back future contributions. An early start on saving, coupled with the power of compounding, will work its magic over time. But if you're a late bloomer, don't despair. By starting now and increasing your contributions a little each year, you could still reach your goal (see How to Save a Million).
Simple Way #2: Get Help from the Pros
If you are automatically enrolled in a 401(k) plan and you don't actively select an investment, your employer is now required to direct your contributions to an appropriate long-term investment, such as a target-date retirement fund, also known as a life-cycle fund. Nearly 70% of employers that offer automatic enrollment default employees into diversified investment options such as target-date portfolios, reports Hewitt Associates. For most workers, this investment strategy is more suitable than the more-conservative default investments used in the past. But it could spook novice investors in turbulent markets.
Still, even a weak stock market can be good news for investors in the long run, says Finra chief executive officer Mary Schapiro. Buying shares of mutual funds when prices are low positions you for big gains when the market rebounds. And most employees benefit from matching contributions from their employer -- often 50 cents on the dollar up to the first 5% or 6% of pay. A guaranteed 50% return on your investment is better than any fund can promise. With regular contributions, most newly enrolled workers will see their account balances grow, even in a down market.
Although automatic 401(k) features tend to target new hires and younger employees, you may benefit even if you are already enrolled in your company plan. Many employers now offer all workers access to personalized financial advice or all-in-one investment solutions, such as professionally managed accounts or target-date funds that invest in a diversified mix of stocks and bonds that grow more conservative as you near retirement.
A recent study by Charles Schwab found that 401(k) participants who received assistance with choosing their investment lineup, whether through advice services, target-date retirement funds or plan-sponsored asset-allocation models, received better returns on their investments than those who decided to go it alone. For example, participants who consulted with an independent investment adviser (a service provided at no additional cost to employees in some plans), earned an average 14% return in 2006. (Those who did not take advantage of advice or who did not use target-date funds earned an average 11% during the same period). "It's common knowledge that not contributing enough to receive the full 401(k) dollar match from your employer is the same as leaving money on the table," says Jim McCool, executive vice- president of Schwab Corporate & Retirement Services. "But employees are also potentially missing out on a valuable benefit if they are offered professional advice at no additional cost and do not take advantage of it."
Broad-based enrollment in a company's retirement plan also benefits high-income employees (those who earn $105,000 or more), who are sometimes prevented from contributing the maximum amount to their 401(k) plan because too few lower-income workers participate. When auto enrollment is extended to existing workers who are not already in the company plan, participation rates can jump to as high as 95% of those eligible, according to the Retirement Made Simpler study, compared with an average 78% of eligible workers who currently participate in 401(k) plans.
Simple Way #3: Check Your Progress
When Steve Frazier, a claims supervisor with Society Insurance in Oshkosh, Wis., reached his milestone 50th birthday, he decided it was a good time to figure out whether his retirement savings were on track. Fortunately for him, his 401(k) provider, the Principal Financial Group, offers free counseling to plan participants at Society Insurance. Nationally, about 40% of employers offer investment-advisory services to employees.
Frazier and his wife, Ann, gathered all of their financial documents -- including life-insurance policies, Social Security statements and IRA information -- and met with a Principal adviser to review their entire financial picture. "I was a little nervous," says Frazier. "I was afraid they might say I could never afford to retire." Instead, the adviser told him he was on track to quit at 62 and encouraged him to bump up his 401(k) contributions from 7% to 10% of his salary just to be safe.
At 51, Frazier is eligible to add an extra $5,000 in catch-up contributions to his 401(k) this year, for a total of $20,500. With two kids in college, however, cash is tight. "I can't contribute the maximum now, but once the kids are out of school, I may try to save more -- probably in a Roth IRA."
POSTED BY: Ray B (June 27, 2008 02:54 AM)
For those of you earning too much to take advantage of an IRA, consider an annuity. It offers tax-deferral, but be careful of fees. There is no limit on how much you can contribute.
POSTED BY: Ronnie (July 01, 2008 02:28 PM)
Also, don't forget just contributing to a traditional IRA, like what's mentioned above. Starting in 2010, you can convert to a Roth without the income restriction currently in place.
POSTED BY: Eric Sharp (September 25, 2008 12:30 AM)
Does anyone remember (a Dept. of Labor) survey conducted regarding a 3% salary deferral for the average worker? The results showed there wasn't much difference in the take-home.. I am looking for that study which was done a couple years ago...
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