IN THIS CHAPTER

Doing yourself a favor by participating

Growing your money

Taking your 401(k) with you to a new job

Supplementing Social Security

You have absolutely no reason not to save for retirement — especially if your employer makes it easy by offering a 401(k) or similar plan.

This chapter offers the obvious and not-so-obvious benefits of 401(k) plans.

You Can’t Afford Not To

Most people can find $20 a week if they really try — that’s about $1,000 a year. Invest $1,000 a year for 40 years, at a 9 percent annual return, and you end up with $338,000. That’s certainly better than nothing — and you’ll probably be able to afford to save a larger amount sooner than you think.

Don’t make the common mistake of expecting it to get easier to save after you start making more money. It never gets easier, so start now. Most people can find ways to reduce expenses without feeling any pain. See Chapter 11 for some suggestions. Also, a tax credit is available to retirement plan participants with low and moderate incomes. Details are in Chapter 2.

The Stock Market Can Be Your Friend

Although a reluctance to invest in stocks is understandable, it’s not a good reason to ignore saving for retirement. Even if your investments don’t produce spectacular results, you’ll still be a lot better off in your retirement years if you save for retirement than if you spend all the money now.

401(k)s often offer some investments that aren’t stocks. Some may offer a stable value fund and other lower-risk investments. If you’re really stock-shy, you can consider lower-risk alternatives available to you. However, remember that historically (on average), stocks have provided the highest return over long time periods than other types of investments and have done the best job of beating inflation, so you should consider including them in your investment portfolio.

The first step to conquering fear is finding out more about what you’re afraid of. Part 4 of this book is a good place to start educating yourself about investment basics.

You May Get Contributions from Your Employer

Many employers make what’s known as matching contributions. These are additional contributions that you get only if you contribute to the plan. The matching contributions usually range from 10 to 100 percent or even more of the amount you contribute. It’s usually limited to the first six percent of pay or less of the amount you contribute.

Some employees I meet suspect this matching-funds stuff is too good to be true and believe there must be a catch. There isn’t. The only way you lose out is if you don’t play — and by play, I mean participate in your employer’s 401(k) plan.

Your 401(k) Money Is Placed Safely in a Trust

The money you contribute to a 401(k) is placed in a trust. The assets of the trust don’t belong to the company, so they aren’t at risk in a bankruptcy. If your employer goes bankrupt, you should eventually get your 401(k) money — although it may take a while. Of course, if you hold company stock in your 401(k), it will be worthless if the company goes out of business.

You can lose contributions that have been deducted from your paycheck but not yet deposited into the 401(k) by your employer. Employers are supposed to deposit contributions into the plan fairly quickly, but some employers violate this requirement. One month’s worth of contributions is the most you’d be likely to lose if your employer is making deposits on time.

Any Plan Is Better than No Plan

If you don’t like your 401(k) plan because you think that the fees are too high or the investment selection is inadequate, don’t simply throw in the towel and not participate.

One strategy you can try is to contribute only enough to get the full company match. (If your employer contributes 50 cents for every dollar you contribute, that’s a 50 percent return on your money right there.) Then, contribute the maximum to an IRA as well if you’re eligible, to boost your retirement savings. You may not get a tax deduction for the IRA contribution, depending on your salary, but you may be able to contribute to a Roth IRA, which allows tax-free withdrawals. See Part 3 for more details about IRAs. Also, try to convince your employer to improve the plan, as I explain in Chapter 14.

Your Account Is Portable

You may be hesitant to join your 401(k) because you’re thinking of changing jobs. Well, unless you have a firm job offer to start next week, I have news for you — things don’t always go the way you plan. You may be at your job longer than you think. And when you do change jobs, you can roll over your 401(k) money into your new 401(k) if permitted or an IRA. Take advantage of the opportunity to save for retirement at your current employer, even if it’s only for a few more months.

You May Be Able to Take Out a Loan

Most plans permit “hardship withdrawals” and/or loans from your 401(k) for approved purposes, such as higher education expenses, buying a home, or financial hardship. I explain the rules in detail in Chapter 16.

Consider saving for other purposes in different types of accounts. For example, keep an emergency fund in something easy to access, such as a money market fund. Save for your children’s college in a tax-advantaged college savings fund. Then put retirement money into your 401(k) or IRA.

Social Security Isn’t Enough

Social Security benefits received during retirement generally replace about 20 to 40 percent of pre-retirement income for someone who retires at Social Security’s “normal retirement age.” (The higher your pre-retirement income, the lower the percentage replaced by Social Security.) But financial planners estimate that you’ll need 70 to 80 percent of your pre-retirement income to have a comfortable retirement.

If you don’t get a pension, you’re left with a gap of 30 to 60 percent. A pension benefit, if you have one, may provide an additional 15 to 25 percent, reducing the gap. How do you fill this gap? Unless you have certain wealth from another source, you need to save on your own. The more you save in a 401(k) or other retirement account, the better off you’ll be.

The Younger You Start, the More You Can Save

Why start planning now (and deprive yourself of cash every month) for a retirement that’s 30 or 40 years away?

To that I answer, compounding. Small amounts of money saved regularly over time can grow to large sums, especially in an account like a 401(k) or IRA-based plan that lets you save without paying taxes on your investment gain each year. Invest $1,000 a year from age 20 until age 65, with a 9 percent average return, and you’ll end up with $525,000. Start saving five years later, at age 25, and you’ll only have about $338,000. See how much better off you are if you start early?

You don’t have to start big, either. Just $20 a week adds up to about $1,000 a year. As you move up in your career and your salary increases, you can increase your contributions, as well — especially if you’re already in the habit of saving. Participating in the plan makes it even easier because your employer does all the work of deducting and contributing to the plan.

Chapter 11 gives tips for developing a savings plan and examples of the benefits of starting young.

You Can Contribute More as You Get Older

Some people in their 50s and 60s worry that they’re starting the retirement savings game too late. If you’re just beginning to save at that age, indeed, you have some catching up to do. But guess what? The age-50 catch-up contribution and increasing federal contribution limits that I discuss in Chapter 15 help baby boomers who haven’t saved enough for retirement save more.

Don’t berate yourself if you’re in this situation. The retirement landscape has changed dramatically in the last 10 to 20 years, and many people were caught unaware by the increased need to save for retirement rather than depend on Social Security and a company pension.

It’s never too late to save in a 401(k) or an IRA-based plan. For as long as you work, even if you’re older than 70½, you’re allowed to contribute to your employer’s 401(k) or IRA-based plan provided you don’t own 5 percent or more of the business. The important thing is to have a plan. Life goes on whether you’re ready or not, so be prepared.