By Peter Passell,
Author of Where to Put Your Money NOW: How to Make Super-Safe Investments and Secure Your Future
Once upon a time, a monthly pension check was the standard reward for devoting decades to a single employer. Now, these sorts of "defined benefit" pensions are as rare as underpaid bank CEOs. But never mind: the 401(k) retirement savings accounts (named for a section of the Internal Revenue code) that have largely replaced them do have some advantages. The tax breaks are pretty good. You -- not some financial swami hired at your expense -- get to decide where to put the money and when to spend the proceeds. And most employers do choose to toss in some cash to sweeten the deal.
What hardly anybody anticipated, of course, was the biggest financial bust since Herbert Hoover explained that "prosperity is just around the corner." If you're like the rest of us who listened to the conventional advice to hitch your retirement wagon to the future of corporate America, you've lost 30-60 percent of your nest egg. And to add to your woes, many employers are planning to drop matching contribution. The way it looks now, instead of a retirement cruising the Caribbean, you may have to settle for some fun nights at the Olive Garden.
But don't resign yourself to the ravioli and garlic breadsticks just yet. While the financial crisis certainly proves that you can't rely on a 401(k) to make all your dreams come true, it is still a solid, flexible way to maximize the value of your savings. And a little rethinking can make it a more reliable foundation for retirement.
So you lost a hefty chunk of your savings in the Wall Street tsunami. The lesson must be to take fewer risks with what remains (and what you expect to add), right? Maybe.
If you're near retirement (over, say, the age of 60), you have no prudent alternatives to limiting risks by keeping a good chunk of your assets in fixed-income securities such as US Treasury bonds, CDs and the like. You could -- and I'm guessing a lot of people will -- see this as a moment to take bigger risks for the same reason that baseball teams that are three runs down in the bottom of the ninth inning swing for the fences. But sports analogy goes only so far. In baseball, after all, the losing team gets to go home and plan for another day.
The lessons for younger workers are more elusive. Certainly the events of the past year should remind us all that, while the average return on volatile assets like stocks and real estate has been amazingly high over the past century, there are no guarantees the money will be there when you really need it. The bottom line, then, for folks with decades left in the work force is to maintain some bedrock savings in low-volatility (alas, low-return) assets, but keep at least half of your savings in securities that have a good chance of appreciating when the economy turns around. And it wouldn't hurt to suck it up, setting aside more of your paycheck to assure a minimally comfortable retirement, even if the stock market lets us all down.
When securities markets are producing double-digit returns year after year, hardly anybody pays attention to advisers' fees. Who begrudges the company that the retirement plan an extra one or two percent on top of the charges already levied by the mutual funds that actually manage your investments?
Well, I do. Remember, those geniuses charged you to lose a third or more of your money in 2008. And there's not a reason in the world to believe that they actually earn their pay even in the best of years. Every serious study suggests that, in the long run, actively managed investment funds rarely beat the performance of randomly selected stocks.
You probably can't do much about the fees charged by your 401(k) plan's custodian/adviser other than to complain, reminding your employer's HR department that some plan custodians -- notably, the big mutual fund groups that make low costs a selling point -- will take on the paperwork for a pittance. But you do have some control over the individual mutual funds in which you invest. And most 401(k) plans give you the option to put your money in index funds just try to make the performance of the market and charge less than quarter of a cent on the dollar for their services.
Remember, too, that if you change employers you can and should roll over your 401(k) into an individual retirement account at a mutual fund group (like Vanguard or Fidelity) that charges nothing to serve as custodian and offers a wide variety of low-cost index fund options.
Rethink Tax Consequences
One big appeal of the traditional 401(k) is that you get to deduct contributions from your taxable income in the year you make them. But this deal isn't quite a free lunch: when you do take money out, every penny is tax at ordinary income tax rates. That suggests it's worth thinking about two tax-minimization strategies.
First, if you are saving more than the maximum annual contribution permitted in a 401(k), make any risky investments -- ones with the potential for a pay-off in appreciation rather than in dividends or interest -- outside of the retirement account. That way, you might could benefit from the lower tax rate on capital gains earned on the money.
Second, remember that many employers now (or soon will) offer a variation on the 401(k) called a Roth 401(k). Contributions to Roth accounts don't give you the immediate tax break. But you never have to pay taxes on income accumulated in a Roth. For most people most of the time, the traditional 401(k) is still the better deal. However, in lean economic times -- if you're temporarily laid off or put on reduced hours -- create an opportunity to shift some of your savings to a Roth account, pay the income tax in your new, temporarily low tax rate, and end up ahead of the game.
©2009 Peter Passell, author of Where to Put Your Money NOW: How to Make Super-Safe Investments and Secure Your Future
Peter Passell, author of Where to Put Your Money NOW: How to Make Super-Safe Investments and Secure Your Future, is a senior fellow at the Milken Institute and the editor of the Milken Institute Review, and has been a columnist for the New York Times. He is the author of many guides to personal finance, including Where to Put Your Money, The Money Manual, and How to Read the Financial Pages.