Rebuild Your Retirement Savings

Last Updated Apr 20, 2009 7:59 PM EDT

Perhaps, in retrospect, the nation shouldn't have staked so much of American workers' retirement security on something as vulnerable as the 401(k) plan. Perhaps you personally wish you'd saved more out of each paycheck or at least started saving earlier. And couldn't you just kick yourself for lacking the foresight back in 2007 to pull your 401(k) money out of the plan's stock funds and move it into the plan's super-safe money funds or stable value funds?

But perfect hindsight can't help anyone now. The market crash has vaporized decades' worth of personal 401(k) saving, and there is no federal bailout in sight for the victims. Any reform of 401(k) plans that might come about will arrive too late to help. If you are in your 40s or younger, you probably have time to rebuild your savings before retirement. If you are in your 50s or older, and you had a lot of your 401(k) money in the stock market, you likely face a far grimmer truth: you may not be able to retire as early or as comfortably as you had planned

But there is a way out of this mess. In essence, you have to create your own personal bailout plan. It won't be fun. It involves making some serious late-stage changes to your plan, and committing to do more in the years you have remaining in your career: save more, work longer, and invest more carefully.

Save More

Don’t count on the markets to dig you out of your retirement hole. It would take a 100 percent stock rally to merely get back to the 2007 market high. That means you need to commit to regularly putting more of your income into your retirement savings. “There’s no magic bullet here,” says Frank Armstrong, author of The Retirement Challenge: Sink or Swim and president of Investor Solutions, a Coconut Grove, Fla., financial-advisory firm. “You need to save more to have more, it’s that simple.” Financial advisers recommend socking away 15 percent of your pretax income for retirement annually; Americans tend to save just half that amount.

Ironically, the plan that got you into this hole — your 401(k) — is the best vehicle to use when trying to save your way out of it. Yes, it’s true that the 401(k) system is seriously flawed. The country needs a retirement strategy that shares risk more evenly between employers, employees and financial institutions. But if you’re over 50, you can’t wait for Congress or Wall Street to invent something better. You need to save as much as you can right now.

Anyone 50 or older is allowed by law to save up to $22,000 a year in a 401(k). That’s $5,500 more than younger people can. Push yourself to take full advantage of this so-called “catch-up” contribution, if possible.

If your company offers a variant on the standard 401(k) plan, called a Roth 401(k), give it a serious look. You won’t get an initial tax break for investing — you have to make your Roth contributions with after-tax income. But once you retire, the money you pull out of a Roth 401(k) is 100 percent tax-free. If you put your money instead into a traditional 401(k), you’d owe income tax on 100 percent of the money you withdraw from the plan. Given the mega federal budget deficits that will need to be repaid in the future, it’s likely that tax rates will only go up from here. This makes investing in a Roth 401(k) — paying now so that you’ll avoid them in the future — all the more alluring.

Committing to saving more will require you to spend less. That’s not just an important step to take today, it will be vital in your retirement years too. “Saving more today also has the added benefit of training you to live on less,” says T. Rowe Price financial planner Stuart Ritter. “That’s going to help in retirement, because you will have a less expensive standard of living to maintain.”

Work Longer

Working longer may seem like a death sentence, but you won’t need to work forever to get your retirement plans back on track. The typical retirement age is around 63 today; you can make up a stunning amount of lost ground if you push your retirement date back to age 67.

Three simple math equations are behind this delayed-retirement fix:

  • Work longer and you’ll have an easier time delaying when you start drawing your Social Security benefits. Every year you forgo taking the payout from age 62 to age 70 boosts your eventual benefit by 8 percent. Delay five years, and you’ve banked a 40 percent higher Social Security benefit, which will help you get along in retirement.
  • Delaying retirement will help your portfolio in several important ways. Your investments will have more time to recover from the recent losses. They’ll have more time to grow before you start withdrawing money. And you’ll reduce the number of years you’ll need the stash to support you in retirement. Think about this: if you retire at 60, there’s a very good chance your retirement fund may need to support you for 30 or more years. Put off retirement to 70, however, and you’ll dramatically lessen the pressure on your retirement fund.
  • If you can keep saving during your later-work years, you will give your retirement account a tremendous lift. T. Rowe Price estimates that someone with a diversified portfolio who works until 67, delays taking Social Security, and continues stuffing 15 percent of pre-tax income into savings can end up with 44 percent more retirement income than someone retiring at 62. Keep working to 70 and you could boost your retirement income by nearly 80 percent.

Invest More Carefully

While saving more and working longer are the crucial drivers of a retirement rescue plan, it’s also important to have the right mix of stocks, bonds, and cash in your retirement portfolio. That’s a lesson many 401(k) investors learned the hard way, since many had tilted too heavily towards stocks last year — sometimes unknowingly.

It’s still important for people over 50 to keep a chunk of their 401(k) money in stocks. With today’s longer life expectancies, a person in his 50s today has an excellent chance of living another three or four decades. While stocks will likely be volatile over that time period, they are also likely to outperform other investments.

Don’t plan to double down on stocks to “get it all back fast,” however. If you had 100 percent in an S&P 500 stock index portfolio in 2008, your portfolio sank 37 percent. With a 60/40 split between the S&P 500 and bonds, your portfolio would have held on much better, losing 22 percent.

In your 50s, financial advisers say, it’s smart to keep 50 to 60 percent of your retirement money in stocks. This will help the portfolio beat inflation over coming decades. The rest of your 401(k) funds belong in your bond fund or the super-safe money funds or stable value funds for stability.

Fixing your retirement fund will take some sacrifice. You’ll need to find a way to save a lot more. You’ll have to stay on the payroll longer than planned. And you can’t recklessly stake all your hopes in a stock market rebound — you still have to be prudent.

But making sacrifices isn’t the same as giving up. Even if you’re in your 50s now, you can salvage a decent, comfortable, and dignified retirement. Your most important tool in the rebuilding process is your willingness and ability to keep working. But the second most important tool, ironically, is the one whose statements you probably can’t bear to look at these days. Until something better comes along, that’s your 401(k).

For more on 401(k)s:

  • Carla Fried

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