Need to do better? Resolve to use this benefit for all it's worth. Your employer often will match your 401(k) contributions from levels of 3%, 5%, or more of your salary. And because you make your 401(k) contribution with pretax dollars, the income you pay taxes on is lower.
Of course, Uncle Sam will collect when you draw on those tax-deferred savings. But in retirement, your income and tax bracket may be lower.
Choosing an investment strategy
Employer-sponsored 401(k) plans offer anywhere from a dozen to literally hundreds of investment options.
For example, CUNA Mutual Group, Madison, Wis., offers retirement plans to credit union employees and to credit union small-business members. "We have one plan with 15 to 20 funds, another that has up to 65 options to choose from," explains Anthony Bosma, a CUNA Mutual retirement and investment representative.
Your employer often will match your 401(k) contributions from levels of 3%, 5%, or more of your salary.
You will probably see index funds among your investment options. Investing expenses are cheaper under index funds because there are no investment decisions to make. Fund administrators just meet the publicly available index match.
You'll typically find 401(k) investments in these asset classes:
- Bonds: short-, intermediate-, and long-term. Bonds also are classified by investment grade, such as "high-yield" investments in "lower-quality" bonds.
- Large cap equity funds: growth, value, or a blend of growth and value
- Small cap companies: growth, value, or a blend
- Mid cap companies: growth, value, or a blend
- International companies: growth, value, or a blend. There also are "global funds" and "developing-market funds" internationally.
- Real-estate funds
- Socially responsible funds
- Money market accounts (MMAs) and other fixed-return investments, such as guaranteed investment contracts (GICs)
Learn about your investment options by studying your 401(k) plan's enrollment books and by looking at the past performance reports on investment funds within the plan. At the same time, always recognize that past performance is no predictor of future performance.
"If you don't have a lot of investment experience, target funds and lifestyle funds offer a quick way to invest in a diversified portfolio," says Bosma.
These are managed funds. Say you pick 2040 as your retirement date. The manager allocates your investment mix for that retirement date. In a lifestyle fund, you state a preference for investing style: conservative, moderate, or aggressive.
If you wonder what kind of lifestyle fund would suit you best, try Kiplinger's Risk Tolerance Test.
Managed funds cost a little more because they're actively managed by the portfolio managers and rebalanced at least quarterly. If you want to make your own choices, study the funds and choose an investment strategy.
Sometimes, your employer will have a financial representative on staff to answer questions. Or you can attend investment seminars. Financial representatives don't make specific investment recommendations, but they can help you determine your investment philosophy and steer you to investing guidelines.
Once you choose a strategy and pick a mixture of stock funds, bonds, and fixed investments, it's up to you to follow your statements and reallocate your blend of funds every six months or at least yearly.
"Reallocating is selling out of one fund and investing in a new one," says Bosma. "Rebalancing is a different story. Some funds outperform others, requiring you to rebalance to get back to your preferred mix of funds."
But, Bosma cautions, don't try to beat the market.
Follow your statements and reallocate funds every six months or at least yearly.
"Even astute investors have trouble timing the market," he says. "That's why you diversify. History shows that diversified portfolios perform better in the long term than just picking an individual stock or bond."
Fees for 401(k) plans are stated in the plan and in each fund's prospectus. They're often stated in basis points (bp); 100 bp equal 1%. There's an asset-management fee that can range anywhere from 50 bp to 150 bp—or more—of your investment balance. There's also a fund-expense ratio of anywhere from 5 bp to 150 bp. It varies according to the hands-on management required in each fund.
Choosing when to retire
How do you know when you can retire? "It depends," says Bosma. It depends on the lifestyle you envision in retirement, your income needs, expenses, assets, health costs, legacy goals, and more.
"An industry guideline says you should plan on having at least 80% of the income you had while working," Bosma says. "When you retire, you go from having a consistent paycheck to making sure you still have close to that same income."
To help you decide when to retire, look at your:
- Income, including Social Security benefits, pensions, wages from contract or part-time work, and annuity payments
- Basic expenses, such as housing, food, clothing, transportation, insurance, taxes, and health-care costs
- Flexible expenses, including travel and entertainment, recreation and hobbies, and gifts; plus a safety cushion for yourself and heirs
- Assets, such as your 401(k) savings, other pensions, IRAs, regular savings, share certificates/CDs, other investments, insurance plans, and personal property
- Insurance coverage, including health insurance, long-term-care insurance, and life insurance
You can use Plan It's Financial Longevity calculator to see how long your money will last. Another useful calculator is the Ballpark Estimate, which helps you handicap about how much you need to save to achieve a comfortable retirement.
These and similar calculators will tell you how much you can draw annually before your funds will run out. The guideline is to draw no more than 4% of the balance in your retirement funds for starters.
Financial representatives can help you determine your investment philosophy.
Legacy goals are what you plan to leave for your heirs and to favorite organizations. The amount you budget for "legacies" also can become a cushion should you need extra money in retirement.
And to make sure you don't run out of money, you might place a portion of your retirement funds into an annuity. Annuities come in fixed and variable varieties and can be structured to pay you, and your spouse, for life and to pay for a "certain" number of years to heirs, should you both die prematurely.
The key to retirement planning is to start early and stick to your retirement plan. Don't raid funds if you switch jobs; roll them forward. The more you save and the earlier you start saving, the earlier you can retire. And then enjoy!
Neither CUNA nor the author of this article is a registered investment adviser. Readers should seek independent professional advice before making investment decisions.
Published May 20, 2011