The combination of company cutbacks and stock market losses has the potential to derail your retirement savings and jeopardize your financial future, unless you take immediate action to get back on track.
In an attempt to keep from laying off workers during the recession, companies of all sizes are slashing expenses. One piece of the cut-back pie includes job benefits, which increasingly are targeted as a way to cut costs. Unfortunately, the long-term implications of these cutbacks on your nest egg could be significant.
Here's an example: If your employer discontinues the 50% match of your
401(k) contributions to up to 6% of your $75,000 salary, you'll lose $2,250 in savings in just one year. And assuming a 7.2% average annual rate of return, that $2,250 yearly contribution would have grown to $100,000 in 20 years from compounded growth, according to Bankrate.com (March 16, 2009).
Rerun the numbers in light of lower balances and economic uncertainties.
If you experience a reduction or loss in workplace retirement benefits, it's imperative you take action and start to play catch-up as quickly as possible. Consider a combination of moves to soften the blow:
- Boost your 401(k) contributions. Losing the company match doesn't mean you should stop contributing. Research from Hewitt Associates revealed that the average employee could bridge the gap caused by a
401(k) match suspension by increasing contributions just three percentage points a year, according to U.S. News & World Report (April 14, 2009). Consider switching to a lifecycle fund, which automatically adjusts to less risky investments as you approach retirement age.
- Redirect spending leaks to personal savings. If you don't have a back-up emergency fund, start one now. This is particularly important if your job is in jeopardy. Ideally, you want three to six months' living expenses handy in a liquid, interest-bearing account in case you need cash quickly. After you've built up a solid emergency fund and you're maxing out your 401(k), then consider an IRA (individual retirement account). Know the difference: A traditional IRA gives you an immediate tax deduction if you meet income requirements, whereas a Roth IRA—funded with after-tax contributions—allows you to take tax-free distributions in retirement. Talk with representatives at the credit union or with your financial adviser about income limits for both.
Losing the company match doesn't mean you should stop contributing.
- Resist the urge to cash out. If you're in the 25% federal tax bracket, a $50,000 withdrawal before age 59½ will cost you $12,500 in federal taxes, $3,500 in state taxes (assuming a 7% state tax rate), and $5,000 because of a 10% early withdrawal penalty, according to Fidelity. That means your $50,000 withdrawal from retirement savings shrinks to $29,000. Hewitt Research estimates that 45% of employees make the costly mistake of raiding their 401(k) when they leave the job. If you're terminated and age 55 or older, there's an exception to the early withdrawal penalty.
- Take another look at your retirement plans. As painful as it may be, rerun the numbers in light of lower balances and economic uncertainties. Use several retirement calculators—including the Financial Longevity tool on this Web site—to figure out how much more you need to save to reach your goals. Also check out Choosetosave.org/ballpark/ and Bankrate.com (scroll down to Retirement Calculators).
Consider a combination of moves to soften the blow.
- Know when you're vested. If your employer terminates your 401(k) plan because of bankruptcy, merger, or acquisition, remember that any pre-tax contributions you made, plus earnings, are yours to keep. The company's vesting schedule, though, determines whether you're entitled to the employer contribution portion. If you're not sure when you're vested, contact your company's human resources department.
It pays to plan ahead and protect what's left of your nest egg. Chances are good your catch-up plan can help you get back on track to a solid financial future.
Published July 31, 2009