401(k) savings advice for Gen-Xers

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(MoneyWatch) A new report that considers how financially prepared Generation-X'ers are for retirement concludes that eligibility to participate in an employer's 401(k) plan is the single most important factor in closing their retirement savings gap. Of course, just being eligible to participate in a plan isn't enough -- you actually have to participate, as well as take several critical steps.

For younger workers today, 401(k)-style savings plans are the primary, and typically only, plan to save for retirement. And how they handle this "do-it-yourself" saving system will spell the difference between being financially secure during their retirement years and living on the edge. Here's a 401(k) action plan for folks in their 20's and 30's.

Join your company's 401(k) plan as soon as you become eligible. Most companies will require you to be employed for six months to a year to join the 401(k) plan, but a growing number of businesses allow workers to participate immediately. So find out when you are eligible to join, and enroll as soon as you can. Also find out how much you need to contribute in order to receive the maximum matching contributions from your employer (assuming one is offered). Most employers will require you to contribute at least six percent of your pre-tax pay to get a three percent employer match.

If you're not eligible to participate in a 401(k) plan, you do have options. Self-employed people can establish and contribute to a self-employed 401(k) plan, where you make contributions to your own account as both the employer and employee, for a total pre-tax contribution of up to $50,000 per year (up to $55,500 if over age 50). If you have $5,000 or more in earnings, you can contribute up to $5,000 (up to $6,000 if over age 50) to an Individual Retirement Account, or IRA.

The point is that having access to a 401(k) is not necessarily a requirement to being able to save for retirement in a tax-advantaged retirement account.

Contribute 10 percent. Most employer-sponsored 401(k) plans will provide a matching contribution on up to 6 percent of employee contributions. But this is not some implied message for what you should be contributing. Several studies have concluded that for the average worker, if you are working and saving for retirement over 30 years and all you will have to draw on is your 401(k) and Social Security, you will need to contribute a total of 13 to 15 percent of your pay each and every year into your 401(k) plan account to have a reasonable chance of having enough money to fund your retirement. So if your employer contributes three percent and you contribute 10 percent, the total contribution would be 13 percent.

Juggling debt payments and retirement savings can also be a struggle. If you have student loans, don't sacrifice 401(k) plan savings to make extra principal payments on these loans. Instead, consolidate your student loans into a single loan with a lower payment, which frees up cash-flow to contribute to your 401(k).

But if you have credit card debt, the advice is different. Contribute an amount to the 401(k) plan to get the maximum employer's matching contributions (typically 6 percent) and then use any extra income to pay down your credit card balances as quickly as possible. That is because while the return on the "matched-contributions" is hard to beat, the return on the unmatched contributions is not likely to exceed the 18 to 29 percent interest rate you could be charged on the credit card debt. If you lack the discipline to go back and increase your 401(k) contributions after you pay down your credit card debt, then just start out at 10 percent.

Make Roth 401(k) contributions. Many plans today also allow a feature called Roth 401(k) contributions. These are deducted from your after-tax pay, but all of the growth on these contributions is tax-free at retirement when the money is withdrawn. This can be a significant benefit to younger workers, who will be investing for a long time and thus can expect to see a longer period of growth for their retirement savings. If your plan offers this feature, then make some or all of your contributions in the form of a Roth 401(k) contribution.

Escalate contributions. If you absolutely cannot afford to save 10 percent of your pay right now, then begin with at least the minimum required to receive the maximum employer matching contributions, and automatically increase your contributions each year to coincide with your annual pay hike. Many 401(k) plans include an automated feature called a "contribution escalator," which you can set up to automatically increase your contributions by a defined amount on a pre-set date in the future.

Invest for maximum growth. According to major 401(k) plan service providers, younger employees invest more conservatively than their parents do, allocating some 35 percent of their retirement funds to lower-risk bond and stable value funds. Studies show that some 19 percent of workers in their twenties have no stock investments in their 401(k) accounts. Clearly, the reason for this is the recent experience with stock funds during the recent financial crisis. But the younger you are, the more time you have to save and invest. As a result, most of your retirement account and future contributions should be allocated to stock funds, which over time should outperform lower-yielding bond funds.

[joreed8]

WOW really do you not read anything?? Time Magazine, Money, Consumer Reports, and just about any other credible news service even the news papers. Maybe you should watch 60 minutes and many others CNBC, CNN, and so on because of the reading problem. Recommending 401K or any qualified plan is the worst thing for them do even if they match. If employers want to match they should use a section 79 plan for their employees. They should offer the private alternative to the 401K plan where the money they put in is accessible if they need it for a House, Cars, and so on. The limits on 401K's plan are incredible. The stealing the financial companies are doing in these plans are even worst. You take money for giving this advise you should be jailed in my opinion. By going to a private plan they get access to their money when they need it. They get high rates of return with no down side risk when the market tanks. The fees that are charged provide safety and security to the families. It guarantees income for life, 401k max for the same amount of income is maybe 15 years. Then there is other living benefits like tax free income, money for cancer heart attack, stroke, and many others. The money passes to their airs TAX FREEE, and their retirement checks are also TAX FREE.

So TAX FREE retirement. High rates of return with no loss guaranteed. Tax free check if you develop cancer, heart attack, stroke and others. Money accessible when you need it or want it. No restriction on when you can retire. The excess money transfers to your airs TAX FREE. Your retirement income is also guaranteed for as long as you live. It allows for you to contribute to this plan even when you don't work for the company you started with anymore. So one plan you use for your working career and if setup with the same amount after tax dollars it can even fund itself during lean years.

You are right about one thing everyone needs to start at 18 contributing to this plan and keep going through the new retirement age of 60 to 65 for those that are 18 and use these plans. 401k's are now what 70 - 80 so you have just enough money to retire and go out with nothing. One last question where is your retirement money at? I bet it is not in a 401K.

[davidd5063]

What EVERYONE should know about their 401K is that, in the absence of financial reforms being blocked in Congress by the GOP, the whole thing is a Ponzi scheme built on pretend profits on credit card loans to people who have no hope of paying them back, but that won't keep the executives and accountants from booking profits and bonuses right up until everyone realizes the money is gone again.

[AZCarolyn1968]

I find it a bit ironic that no one has commented on the age issue of the article. He writes about contributions for GenX. I'm a GenX and I'm 44, not 20. And my generation is about 33 to 47. This article is slated towards the Millenial's, not GenX. Perhaps in addition to figuring out what's right for the younger generation, he should also put out an article that's appropriate for GenX .

[JLMONEYMAN]

ROTH IRA! BUY TERM LIFE AND INVEST THE DIFFERENCE, GET OUT OF DEBT BY STACKING THEM, PAY CASH FOR PURCHASES, ONLY GO FOR THE BEST BARGAINS!
You're income is your GREATEST wealth building tool! If your company has a 401k match plan, invest in the match! It's FREE money! but realize you'll be taxed later. If you don't like the sound of that go for a ROTH IRA, Personal retirement account! If you lose your job, it goes with you and it's tax free at withdrawal! Take $10,000 put it in at 10% and never touch it again and in 30 years you'll be looking at $198,374.04 ! and you only had to pay taxes on the original 10k.... It's pretty simple to me. Follow the KISS principle and you'll be just fine.

[TommyJohn84]

I always advise people NOT to put contributions over the match and if there's not a match then find a better tax advantage savings vehicle. There's really 3 buckets that you should have money put into; short term(6-12 mths), intermediate(1-10 yrs) and long term(10+ yrs). Each bucket has its own liquidity standard. Obviously the longer out the higher the risk. 401k falls into this one BUT there are other vehicles out there like the Roth IRA, whole life ins.(cash value), and many other ways. I've always been against putting all your money into a 401k. I yell at my dad all the time b/c he does that and he should have 56% of his portfolio into a conservative fund and 44%(100yrs old - his actual age) in risk but he has upwards of 100% of it. One big hit in the market when he's that close to retirement and POOF there goes all his money.

[JLMONEYMAN]

How can you recommend whole life insurance. Just because of that, I can see that you have no credibility. My clients BUY TERM and invest the difference. and they're better off for it.

[leocat99]

I agree with tommyJohn. I would not put any money above the match into a 401k. That money is locked up and if you pull it out early you will pay a big penalty. If you wanted to make a big ticket purchase, i.e. a car, a house, lose a job, want to start a business and need money etc., the money locked up in a 401K does you no good.


The only way I would put money above the match is if all of my debts were paid off, and I had a 4 to 5 years worth of income in cash. Then and only then would I bump up my 401K contribution.

[adv121]

Most of this article is wrong. Participate in the 401k plans up to the amount the employer matches, but no more. Take the rest and diversify outside your company, because if the company has financial difficulties your entire account is at risk. Use IUL, pensions and ROTH accounts of your choice-they generally have more and better choices, lower fees and allow a much better diversification strategy. If you aren't getting "paid enough" to invest, you need to change your spending priorities and look for another job.

[leocat99]

Many companies have 401K accounts that are held and managed apart from the companies finances. I'm not sure, but I believe this is law. I worked for a company that went bankrupt and I had no problems after the fact of keeping the entire value of my entire account and moving it over to a vanguard retirement account long after the company shut it's doors. I agree the smarter move would have been to move my 401K over to vanguard right after leaving the company, because it opens up an lot more investment options (and at lower fees) than the 8-10 choices I had under the company plan, and consolidates more of my money "under one roof." I had 401K plans from 3 or 4 former employers, and I finally moved most of it into one account under vanguard.

[bobmrik]

What about all of the companies who DON'T match? Nobody ever seems to talk about them. Where is all the benefit from putting your money into a non-matched 401(k)? My wife's company stopped the match in 2009, the same time they cut everyone's pay 5%, and no raises since. How is anybody supposed to save anything for the future when the present is so screwed?

[JLMONEYMAN]

HEY BOB!! The answer to your question is simple. Open a Roth IRA, Invest in mutual funds and diversify! Start with 25% in Large Cap, 25% Mid Cap, 25% small cap, and 25% in either international or global. See what pans out for you my friend. be sure you have a good TERM life policy to cover your income and assets too. Don't let these goobers suck you in to Whole (cash value) Life. it's a product created to benefit the agent and the agency, not the consumer.

[WillCD]

Hey Bob. GREAT point. And I agree with you 100% that there is no point in putting your money into an unmatched 401k. Guys like JLMONEYMAN wants you to put your money into mutual funds, which carry high fees, making it nearly impossible to be successful. There are GREAT solutions for you and your family, but they don't lie in traditional thinking. Please contact me to discuss solutions. [e-mail]

[nobelaries]

Sign the petition to Set 401k Money Free!

www.Set401kMoneyFree.org

The 401k, IRA and others alike are a scam to trap Americans into payng taxes at a to be determined rate on todays wages!!

[chriscmiles]

Isn't this the same advice they were giving baby boomers in the 90's? How is that working for them? The biggest difference I see now is that they are telling you to save more. Isn't that brilliant? See this post about the subject:

http://www.fireyourfinancialadviser.com/blog/2009/10/why-its-time-to-retire-your-401k/

Also, pay attention to the final point Ray makes - "...most of your retirement account and future contributions should be allocated to stock funds, which over time should outperform lower-yielding bond funds."

Notice he says "should outperform" in this phrase. There's no risk to him to give the same advice that hasn't worked yet. The last 15 years of the S&P 500 has only produced an average yield of 2.6%/yr. Maybe we should pay off those student loans too? Also, being a business owner myself, why would I pay my own match? There's no tax advantage, and if I lose money in that investment, I can't write it off. I'd rather invest my money in my own business where I control my returns AND get a tax advantage.

[WillCD]

This article needs to be pulled for false information. 401ks and IRAs are not "tax-advantaged".

Everyone I know with a 401k or IRA has paid a TON of interest over their lifetime because they did not have access to their money. They have auto loans, credit card debt, HELOCs, etc. The interest paid to these entities will far outweigh the interest earned in their qualified plan accounts.