IN THIS TUTORIAL   Max out Your 401(k) Make a Plan Padding Your 401(k) Just Do It Know the Rules Don't Borrow Trouble

401(k) PLANS
Make a Plan

Although about 80% of workers eligible to participate in a 401(k) plan do so, only 42% of U.S. workers report that they have ever calculated how much they will need to save for retirement, according to the Employee Benefit Research Institute's 2004 Retirement Confidence Survey.

That's down from a high of 51% in 2000, when record market highs made projecting future 401(k) balances and planning for retirement a lot more fun. Of those who crunched the numbers, about 40% said they had made changes in their retirement planning as a result, including saving more or changing their investment allocations.

So how do you come up with the right amount to divert to your plan?

Financial planners have traditionally estimated that retirees need 70% to 80% of preretirement income to maintain their standard of living, but individual situations vary greatly. Paying off a mortgage before retirement can substantially reduce need for income, while paying for health insurance can radically inflate it.

H. Jon Miller, vice-president of the personal financial-planning division for the Northern Trust Co., offers a shorthand formula for figuring out how big a nest egg you need to finance your retirement. Starting at age 65, figure you can spend 4% of your retirement portfolio each year without running out of money.

Here's the math: Assume you need $75,000 a year and that social security and a company pension will provide $30,000 of it. According to Miller's formula, if you divide your unmet need ($45,000) by 0.04, you need to start retirement with a portfolio worth just over $1.1 million.

Taking the time to figure out how much you will need after your paycheck stops could mean the difference between a comfortable retirement or working a lot longer than you had planned.

The "How much do I need to save?" calculator can help you reach a rough estimate.

According to Tom Schlossberg, president of Diversified Investment Advisors, in Purchase, N.Y., a leading retirement-plan provider, "Once you go through the process to figure out how much money you will need in retirement, then you can figure out how much of your salary you should be deferring in your 401(k) plan and how you should be investing that money to reach your goal. For example, if you are having a hard time deferring 5% of your income and yet you need to set aside more to reach your goal with your current investments, maybe you should adjust your strategy to be more aggressive."

You can use the "Test your risk tolerance" worksheet to determine how aggressive you should be, or you could look for other ways to pad your 401(k).

Diversify your investments

Regardless of what's offered inside your plan, your objective is to earn a reasonable return over a long period while limiting risk. Market cycles tend to favor one type of investment at the expense of other investments. But cycles change, and because no one knows when that will happen, it's wise to spread your investments over several categories.

If your 401(k) plan is your only major retirement investment, distribute your money among several funds, advises Michael Conn, chief executive officer of Investment Management Associates Inc., in Denver. But if you have investments outside the company plan, make sure your overall retirement stash reflects a good asset mix, even if it means your 401(k) plan is heavily concentrated in one or two areas.

Two-income couples should adopt a similar strategy. "You should look at the two 401(k)s as part of a whole," Conn adds, allocating your contributions to the best funds each of your plans has to offer.

Of course, you have to work within the investment options available to you. Typical plans offer about eight investments, including stock and bond mutual funds; balanced funds, which invest in both; "lifestyle" or asset-allocation funds, which include a mix of investments based on your age and how much risk you are willing to take; and fixed-interest investments, such as GICs, or money-market accounts. An increasing number of plans now allow participants to "self-direct" their account by buying individual stocks and bonds.

Where to put your 401(k) money

These charts offer snapshots of possible asset allocations for conservative and aggressive investors 20 or more years from retirement, and all investors five or fewer years out.

Max out Your 401(k)

Padding Your 401(k)