Using Your 401k to It’s Fullest Advantage

Posted by: cworrall on Monday, May 12th, 2008

Historically, your retirement savings were comprised of three legs: social security, pension, and personal savings. The belief was that these amounts would be equal and would replace a certain percentage of your working income to provide you with enough money to sustain your lifestyle after retirement.

Somewhere along the way in the last twenty or so years, companies realized how expensive it was to provide a defined benefit plan (meaning you were guaranteed a fixed sum per month upon retirement). Improved healthcare means retirees are living longer than was expected when the plans were originally set up.

With pressure from Wall Street and general economics, companies began cutting these plans in favor of defined contribution plans (meaning the company will put some amount in, but will not guarantee what will be there when you retire). The best known defined contribution plan is the 401k plan.

By switching from a pension to a 401k plan, the company saves significant money, but places the onus of saving for retirement entirely on the employee. At the same time, the savings rate of Americans has dropped from the 8-10% rate seen in the 60’s and 70’s to 1.2% in 2007.

What this means is that most people have no savings and no idea whether their 401k will cover their retirement or not. Let’s say you are retiring next year (at 66) and you have averaged $65,000 per year for the last thirty five years. You will receive about $22,000 in social security.

To make up the difference, you will have to have $43,000 per year to maintain the same standard of living. Ignoring inflation, if you expect to live another 17 years, you need $731,000. Saving that amount of money is hard, but it can be done.

A great place to start is the 401k offered by your company. In 2008, you can contribute up to $15,500 each year and at most companies, that amount is matched at a certain percentage rate. If you were able to do this for twenty years, you would have the money you need for your retirement. This is due to compound growth and the fact that your retirement funds grow tax-free.

Don’t miss out on this great benefit. Chances are you are already enrolled. The Pension Protection Act of 2006 encourages employers to automatically sign up their employees. All you need to do is start your contributions and you will be on your way to a fiscally healthy retirement.

Topics: Individual, Retirement

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