Last Updated: June 22, 2009
If you're 55 or older and saving for retirement using a 401(k) plan, it's quite possible that you may have to increase the amount of money you contribute to your plan, take advantage of catch-up provisions, tweak how you invest, and perhaps even consider delaying retirement.
According to a just-released study from Mercer, Americans age 55 and older have lost on average 16 percent in their 401(k) plans since the end of 2007 through the end of April 30, 2009, which may pose a problem for those on the cusp of retirement said Mercer. "Near retirees face a huge challenge in accumulating adequate savings for retirement in the midst of recent economic volatility, said Mercer in its release.
According to Eric Levy, business leader of Mercer's retirement outsourcing department, there are several reasons why near retirees are in such dire straits. One, the percent they contribute to their plans is down and should increase, especially to take advantage of the catch-up contribution provisions. Mercer said 401(k) participants over age 55 have cut their pre-tax contribution rates from 9.2 percent in September 2008 to 8.8 percent in April 2009. What's more, only 8 percent of participants over age 50 who contributed in 2008 took advantage of catch-up contributions. According to the Internal Revenue Service, Americans age 50 can increase the amount they contribute to their 401(k)s and individual retirement accounts (IRAs) by certain amounts each year as a way to "catch up" or make up for money they did not save when younger. In general you can save $11,500 in your 401(k) each year, and an additional $5,500 if you are 50 or older. Learn more about catch-up provisions.
Levy also noted that 401(k) plan participants might consider tweaking how they invest their 401(k) as well, especially given the time it may take for their portfolio to return to pre-October 2008 levels. According to Mercer, older investors have become much more conservative investors since the crash of 2008, with the amount invested in capital preservation funds rising from 30 percent to 39 percent. With that type of allocation, Mercer suggested that the average older 401(k) plan participant would need to earn more than 13 percent per year for two years or 5.44 percent per year over five years for their portfolios to return to their pre-2009 level. "Since the level of investment returns required for a quick recovery may be difficult to achieve, older participants may need to either substantially increase contributions, or significantly delay retirement," Mercer said.
Indeed, Mercer suggests that plan participants would need to contribute either 25 percent of their pre-tax income for two years or about 15 percent for five years to recoup the losses in their 401(k) plans.
Financial planners agree with Mercer's suggestions. "Generally speaking, if someone has extra cash in hand and is trying to figure out what to do with it, the 401(k) catch-up provision should certainly be considered," said FPA member, Richard J. Krasney, CFP®, of RJK Wealth Management, LLC.
Likewise, Krasney suggested that you may want to tweak your allocation, but not become too aggressive. "While many people are certainly more cautious about putting money into equities after the market collapse, I would remind investors that money invested into 401(k) accounts need not be invested aggressively. The taxes potentially saved through the contribution deduction amounts is a guaranteed instant return through the taxes saved."
Krasney also mentioned, your investment strategy depends on your circumstances, financial needs, and appetite for risk. "Someone with a long time horizon who is using a dollar-cost averaging strategy may find that this turned out to be one of the best environments for buying when we look back," he said. "The right answer depends on your situation but the 401(k) contribution catch-up still remains one of the easiest and most effective ways to save taxes and invest for one's future."
You may want to consider hiring a financial planner if you need help determining the right asset allocation for you and/or whether you should take advantage of catch-up provisions. Find a financial planner.