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A 401(k) Checkup to Keep Your Retirement Savings in Shape
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By Clifton Linton
Senior Writer, mPower |
Carmela Elco's fall ritual isn't raking leaves -- it's
giving her 401(k) plan a thorough checkup.
Over the course of a few weeks every autumn, she pokes and
prods her plan to make sure that it remains healthy and that she gets the most out of it
so she can stay on track for retirement.
Why do it in the fall? Because, she said, the first two
quarters of the year are busy with paying off the holiday bills and doing taxes. "In
the fall, you know what you have put in. As far as the market goes, you know what's going
on," she added.
Doing a checkup in the fall still gives her time to make
any last-minute adjustments before year-end. It also gets her ready for the coming year.
While 401(k) plans are fairly low-maintenance retirement
savings tools, they aren't no maintenance. The government changes the rules
affecting plans every couple of years, and employers constantly tweak their plans in
response to employee needs. You need to keep up with rule changes, as well as changes in
the investment markets, so you can maximize this key retirement benefit.
An annual check-up at a time that works best for you (it
doesn't have to be in the fall) is a good way to do this. Whenever you do it, it'll
probably be a lot less uncomfortable than being asked to "turn your head and
cough."
Eight-step Checkup
1. Review your plans -- Ask yourself, are you on
track to reach your retirement goals? Have you even thought about retirement? What would
you like to do in retirement? Are your plans realistic and up-to-date? The American
Savings Education Council (www.asec.org) has a "Ballpark Estimate" worksheet
that can help you determine how much income you might need in retirement.
2. Maximize your contributions -- If you're not
contributing the maximum possible to your plan, try increasing your contributions,
suggests Ted Benna, the creator of the first 401(k) plan.
Try boosting your contributions by 1 percent of salary. It
may not hurt as much as you think. For example, if you earn $50,000 a year, a 1 percent
401(k) contribution boost is only $500, or about $42 a month. If you contributed that
amount, extra, each year for 20 years, and if your savings earned an 8 percent annual rate
of return, you would end up with an extra $22,881. While that $500-a-year contribution may
seem insignificant today, it can really add up over time.
Be sure to contribute enough to get a full employer
matching contribution, providing one is offered. In many cases employers will match half
or more of your contributions, up to a certain percentage of salary.
If you can contribute more, try to put in enough to take
advantage of this year's new, higher contribution limits. In 2002, the maximum individual
pretaxl 401(k) contribution limit is $11,000, up from $10,500 in 2001. Also, workers age
50 and older are permitted to make an additional $1,000 catch-up contribution, provided
such contributions are allowed by their plan.
By the way, if you aren't even enrolled in the 401(k) plan
at work, join now -- even if you are only a few years away from retirement. Enrolling will
at least give you some extra savings in retirement. It's never too late to start saving.
Strategy: A good way to start saving or to boost
your savings is to coordinate your contributions with any raises you receive, suggests
Elco, who is also vice president of client services with Resources for Retirement Plans
Inc., a 401(k) plan consulting firm. Most of us adjust our spending to our available
income. By coordinating a 401(k) contribution increase with a new, larger paycheck, the
pain should be less severe than if you try to adjust after getting used to the
additional money.
3. Review your allocation -- Ask yourself if your
asset allocation is proper for your stage in life. Have you had a major life change in the
past year?
As major life events unfold, folks commonly consider
changing their allocations because their priorities change. For instance, some folks
nearing retirement and worrying about the loss of principal may decide to shift some of
their assets into more conservative investments.
4. Rebalance -- Rebalancing is the process of
adjusting your portfolio's investments so they match your original allocation. You should
have set up this allocation by considering your risk tolerance and developing an
investment strategy that would maximize your potential returns for your risk level. When
your portfolio gets out of balance, you may stray from your original risk profile.
Rebalancing keeps your portfolio risk within your tolerance limits.
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| "(Rebalancing) forces you to sell
high and buy low. It increases the overall return of the portfolio over time." |
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| David Wray, president of the Profit
Sharing/401(k) Council of America |
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You rebalance by selling assets that make up too large a
proportion of your portfolio and using the proceeds to buy back those that have become too
small a proportion. The net effect, says David Wray, president of the Profit
Sharing/401(k) Council of America, is to "force you to sell high and buy low. It
increases the overall return of the portfolio over time."
5. Check beneficiaries -- Your spouse is
automatically the primary beneficiary of your 401(k) plan. But, if you are divorced,
widowed or remarried, you might consider reviewing your beneficiary designations to make
sure the correct person is named.
Also, if you want to name someone else (such as a child) as
your primary beneficiary, and you are married, your spouse needs to sign a waiver of
rights to your 401(k) benefits.
6. Check on plan changes -- Does your plan offer new
investments, new plan features, or new contribution limits? What can you do to take
advantage of these opportunities?
7. Create a loan exit strategy -- If you have a loan
from your 401(k), do you have a contingency plan to pay it off if you leave your employer?
Many folks are surprised when they change jobs that they receive notice to pay back back
the loan balance immediately or accept it as a taxable distribution from their plan. (They
would also have to pay a 10 percent early withdrawal penalty if younger than 55.)
Strategy: The reason many folks take a 401(k) loan
is that they have no other source of funds. PSCA's Wray suggests making sure your credit
card limit is high enough to enable you to take a cash advance to pay off the loan if
necessary. "This is the one time I would advocate that approach," he said.
But, this strategy carries tradeoffs. On the one hand, if
you take the 401(k) loan as a distribution, the taxes and penalty might end up being more
costly than the credit card interest (especially if you look at the long-term effect on
your retirement savings). On the other hand, it may not be advisable for you to rack up
more credit card debt, especially if paying it off might force you to stop making 401(k)
contributions. Also, if you do roll your loan onto a credit card, to keep the interest
charges to a minimum, try repaying the balance at the same rate as you were in your 401(k)
plan.
Wray's strategy would "work perfectly if you can roll
your old 401(k) to your new employer and take a (new) loan and pay off the credit
card" right away, said Ginita Wall, a CFP and author of Your Next 50 Years.
8. Keep a long-term view -- Kay Shirley, a certified
financial planner in Austin, Texas, offered a novel approach to the annual checkup. Rather
than focusing all your attention on the dollar value of your investments, look at the
changes in the number of units or shares. You may notice, over time, that even though your
account value is down, you are buying larger quantities of shares of each fund with each
contribution.
By default what you are doing is dollar-cost averaging.
This also has the effect of loading up your portfolio in advance of a rally. So, when the
rally comes, "you will eventually make money," she said.
In the same vein, every five years or so, review your
investment returns. Compare your funds' performance to their benchmarks and their peer
groups. If yours are underperforming and your plan offers similar, better performing
funds, consider changing your investments to the better funds. If this is not an option,
ask your employer if your plan could offer more (or different) investments.
Done in 60 Minutes
The first time you do this checkup it may take you an
afternoon or weekend. But the next one should be easier -- after the first time,
subsequent checkups shouldn't take more than an hour, experts say.
Gather your statements, prospectuses, summary plan
description and any other documents, and go to it!
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The information provided here is intended to help you understand the general issue and
does not constitute any tax, investment or legal advice. Consult your financial, tax or
legal advisor regarding your own unique situation and your company's benefits
representative for rules specific to your plan.
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premier online community resource for 401(k) participants
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