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How to hatch a retirement plan

As company-managed pensions go the way of the typewriter, individuals must take on the responsibility for managing their retirement accounts. Here is a guide for mastering the basic concepts. By Gayle B. Ronan
Duane hoffmann /

As company-managed pensions go the way of the typewriter, individuals planning for their golden years must take on the responsibility of managing their own retirement funds, whether in an employer-sponsored 401(k) plan or a non-corporate individual retirement account.

Yet as wave after wave of surveys indicate, most are faltering under the weight of this responsibility. From just deciding to participate and how much to save, to investing those savings, many are overwhelmed.

Saving for retirement and managing those savings should be neither mysterious nor overly complex. With fast answers available online and many plans designed to provide autopilot options, all it requires is a basic understanding of some key concepts and, of course, action. To that end, here is a guide to mastering the concepts needed to manage these plans and improve the odds that when retirement does roll around, you will have sufficient savings to make it a comfortable one.

Social Security isn't the answer
With Social Security under financial pressure from the graying baby boomer generation, no one should be counting on it for funding all their retirement income needs. 

“The system was never intended to supply 100 percent of retirement income, only (to) serve as a safety net,” says Andrew Eschtruth, spokesperson for the Center for Retirement Research at Boston College.  Given its funding problems, Social Security is even less likely to be a main source in future decades.

Because of changes made to the system in the 1980s, the age at which you can receive full Social Security retirement benefits is gradually rising. Anyone born before 1938 was able to draw full benefits beginning at age 65. But for those born in 1960 or later, the full retirement age is 67. If an earlier retirement is sought or an individual is forced into early retirement due to failing health, having a nest egg to fall back is crucial.

Save the right amount
Though the majority of those with access to a 401(k) plan now participate, about one in five still does not, which can be a very costly mistake.

“At the very minimum, even younger or lower-income workers should be participating enough to trigger the employee match offered by many firms,” says Eschtruth. Not contributing enough to get the match is like volunteering to work for less than a co-worker who is contributing to a 401(k) fund.

But simply saving up to the "match" is not enough. More than half of workers 55 and older have saved less than $50,000 toward retirement, according to an April survey by the Employee Benefits Research Institute. That is not enough to ward off financial disappointment in retirement or, for that matter, support a retirement likely to last 20 years or more.

“It’s our biggest concern,” says John Gannon, vice president investor education at the National Association of Securities, the regulatory authority overseeing the securities industry. “Given the low level of assets in retirement plans, it is clear most savers have not taken the time to calculate what they need to be saving.”

Gannon, like many others, believes it is math, not an inability to save more, that threatens to undermine future retirees. Yet online calculators make it easy to at least get a ballpark estimate of what you need to contribute.

“The truth is you cannot save too much,” says Eschtruth. But given the rather small amounts many individuals have accumulated so far, too many are saving too little.

While doing savings projections is important, they are only helpful if the inputs are accurate. According to a new study by Merrill Lynch, using traditional input may be creating too much pessimism regarding overall financial preparedness.

“The old notion of working for a company for 30 years, having a party and going off to spend the rest of one’s days playing golf in Florida is not happening today, and it is not what the next generation of retirees aspires to,” says Michel Falcon, head of the retirement group at Merrill Lynch.  “We find most people want to transition during their 50s or 60s into different careers or part-time work, something that will give them greater flexibility” to keep working much longer than most planning material indicates.

This has positive implications for meeting savings goals.  It means as long as good health prevails, individuals may not need to tap into their retirement savings until much later in life, giving their savings more years to build within tax-advantaged accounts.

Stephen Mitchell, a director in the retirement group at Merrill Lynch, adds: “We see this as the longevity bonus decade. People are living 10 years longer. Social Security has pushed its retirement age back, so too are workers.  It’s something we overlook in this industry, this redefining of retirement age.  It makes the financial equation a lot more attainable and enriching.”

Max out the retirement plan first
“Our data indicate not everyone understands where to save for retirement,” says Gannon. “Employee-sponsored plans offer tax benefits and matching contributions and should be taken full advantage of—along with IRAs—before other, more costly options are considered like variable annuities.” 

While participating at least enough to receive the employer match is the minimum everyone with access to a 401(k) should be doing, too few are taking full advantage of the ability to build more substantial balances within these tax-sheltered accounts. Only an estimated 11 percent of all 401(k) participants contribute the legal maximum, according to the Federal Reserve’s 2004 Survey of Consumer Finances.  The typical contribution rate is 6 percent of salary.

The limit for annual 401(k) contributions is currently $15,000.  Employees age 50 and over can add an additional $5,000 per year.  There is plenty of room for participants to do more than they do now.

The role time plays
When it comes to retirement savings, you can put time on your side. The longer money has to accumulate, the more it grows.  The key is compounding. It supercharges returns as earnings reinvest, so that even modest amounts of saving, when made early and regularly, can grow into impressive amounts of wealth. It is the reason postponing makes little sense.

“Start young.  The $10,000 to $20,000 you can put away in your 20s is what gives you the options and confidence in your 50s to do what you want to do,” advises Falcon.

While time can boost a low savings rate, it also can help poorly timed investments.  That is because over time, the value of equity assets tends to rise.  Values do not move straight up—as anyone who has ever invested in the stock market can attest.  But over time, there is appreciation.  This is why when saving for retirement, where the investment horizon is typically long term or more than 10 years, exposure to stock markets—both U.S. and international—is highly advisable. 

One of the most dependable ways of hedging against the effect of market volatility is to invest in regular increments regardless of what the market is doing.  This is known as dollar cost averaging.  By default, that is exactly what regular investing through a 401(k) plan or an IRA does, which is why experts are so certain they will be effective retirement savings vehicles.

While many workers begin contributing to 401(k) plans at rather young ages, a recent study by Hewitt Associates found nearly 45 percent of employees cash out their 401(k) when switching jobs. There are serious ramifications to doing that, says Gannon. By not rolling over retirement funds — no matter how small the balance may seem — into an IRA or a new employer’s 401(k) plan, individuals not only deprive themselves of needed savings later in life, they end up paying added income tax on the withdrawal along with a 10 percent penalty if that withdrawal occurs before the age of 59 ½.

No one is well served by putting all their eggs in one basket.  Portfolios need to be well-diversified across asset types including stocks and bonds to accomplish the primary objective of appreciating sufficiently over time to outgrow inflation and fund a healthy retirement.  

Retirement investors make it easier on themselves by having mutual fund managers do the dirty work for them.

“We don’t want people to think it is too complicated. It is not,” says Gannon.  “One can achieve asset allocation and diversification with one to three mutual funds.  It doesn’t take that much effort to get it right.  It just needs to be done.”

Most 401(k) plans offer balanced fund or target fund options, where the fund manager makes all the allocation decisions for the investor. Target funds, also known as life-cycle funds, are allocated to be appropriate to an investor’s targeted retirement date. Because target funds are designed to stand alone, it makes them a decent default setting for individuals who do not have the time or inclination to actively manage their funds. 

“So called ‘set-it-and-forget’ funds can be a good choice if they are well-designed and low in cost,” says Greg Carlson, mutual fund analyst with Morningstar, the securities research firm.   He defines low-cost as having an expense ratio no greater than 1 percent.  “Looking at cost is really best determinate of long term return for any type of fund,”  he adds.

Carlson notes when looking at year-end performance tables, the set-it-and-forget-it funds are rarely at the top of the performance list.  “The most stable funds are not on those lists because they are designed to be stable over time and let you sleep at night,” says Carlson.  While they may not set the world on fire from year to year, over time their returns are expected to be competitive with those funds that do take turns in the top performing positions. These funds are the tortoises in a world of hares.

Rebalance your holdings
Often new money is directed toward stable value funds or cash equivalents where, if it is not moved into something with better returns, it can sit producing mediocre returns indefinitely. Similarly, after the stock market has had a good run or a specific fund has done very well, it may grow to dominate a retirement account, overshadowing better-performing assets in the future. Outsized positions are common in large company plans, where matching funds are often invested in the employer’s stock. Such heavy concentrations of stock in one company’s stock create a risky situation if investors fail to rebalance.

Too much of anything is inadvisable -- as thousands of former Enron employees can attest.  Unless you are fully invested in a target or balanced fund, you need to remember to spend a little time each year — at least once a year — reviewing your investment choices and making any necessary changes to return their account to the allocation they feel is best for them.  Rebalancing, say the studies, is something that all investors need to do, but very few actually do.

Women need more
Many workers significantly underestimate how long they will spend in retirement.  A survey by the Employee Benefit Research Institute found that while men and women plan to retire at similar ages, they also tend to estimate they will spend the same amount of time in retirement similarly. This is a problem because women, on average, live several years longer. Failing to take that into account puts woman at more risk of outliving their savings. In this case, women are not equal to men.  They need to save more.