YOU ARE HERE: LAT HomeCollections


Taking the Slow Road to a Comfortable Retirement

401(k): It can be one of the most important things you can do in your working lifetime. But planning early is essential.


Call it the ultimate get-rich-slow scheme or how to make a heavyweight fortune on a lightweight salary. Either way, 401(k) savings plans--the terrific company benefit with the terrible name--have become a crucial tool for a comfortable retirement.

Admittedly, spending time preparing for retirement can seem like an absurd exercise for workers in their 20s or 30s. At those ages, the notion of some day being as old as your grandparents can seem pretty unlikely. But if you're lucky, it actually happens, so you might as well have enough money when you get there to live comfortably.

"This is one of those benefits that you might not appreciate when you're younger but it really is one of the most important things you can do during your working lifetime," said Steve Merritt, author of the book "How to Build Wealth With Your 401(k)."

Several trends have made 401(k) retirement savings and investment plans, which are named for the tax code that covers them, increasingly important, experts say.

Federal legislation signed into law last month is expected to persuade even more companies to offer the plans. The new rules, effective in 1997, will simplify the administrative burden of 401(k) plans for companies with 100 or fewer employees.

The same legislation allows some nonprofit groups, such as trade associations, to make the plans available to their employees for the first time.

The second issue propelling 401(k)s is the uncertainty surrounding the traditional retirement scenario: Your company pays you a set amount each year after you retire and Social Security will account for most of the rest of the money you need to live on.

That picture has changed dramatically. The most pessimistic prognosticators predict that Social Security will go belly-up early in the next century. Even if that doesn't happen, it's a pretty safe bet that future retirees will receive fewer benefits than they anticipate or be forced to work longer before retiring.

Additionally, far fewer companies now offer the traditional pension plans that guarantee a certain monthly payment at retirement. Only about 120,000 companies provide these defined-benefit pensions today, about half as many as in 1984, according to Access Research of Windsor, Conn. That number is expected to continue to decline.

"401(k) plans are the most popular plans out there right now," said Roy Oliver, the partner in charge of compensation and benefits for accounting and consulting firm KPMG Peat Marwick in Los Angeles.

The basic premise of a 401(k) is this: A little pain early in life--setting aside a small portion of your paycheck--can make for a big gain later--a large pot of cash when retirement arrives. That will probably be sometime after you reach 59 1/2, the age the government allows you to begin withdrawing your 401(k) funds without major tax penalties.

To make people more willing to swallow the pain, the government provides an important sweetener and employers often add one of their own.

The government allows you to contribute pretax money to your 401(k)--which lowers your taxable income--and then allows you to avoid paying taxes on the money and the returns it earns until you withdraw it for retirement. Many employers match some of your 401(k) contributions. It's sort of like getting a raise without having to beg for it.

So just how much can you save through a 401(k)?


Take a 25-year-old worker earning $30,000 a year who sets aside 8% of her paycheck before taxes are taken out, and is in a plan where her employer matches 50 cents on the dollar and her investments earn 10% a year. Even in the unlikely event she never gets a raise during her career, she would be looking at $1.6 million in retirement savings when she hits 65, based on annual compounding, not exactly chump change.

Without the benefits of a 401(k) plan, that same worker would have about half that amount awaiting her at retirement.

With that kind of extra money in the wings, you'd suspect that everyone eligible for a 401(k) would take advantage of it. While about 22 million people are enrolled in the plans, according to Access Research, surveys show that 25% of people who could be in the plans are not--about 7 million people. A substantial portion of those are believed to have no other pension plans to fall back on, meaning they are making no financial preparations for retirement.

The reasons people don't join vary from an unwillingness to plan for something that seems so distant to falsely assuming that their employers provide some other type of pension.

Other reasons people give for not joining include not being able to afford even a small slice taken from their check to not understanding investments enough to feel comfortable participating in the programs.

Workers who think they are unable to afford it should try to adjust their budget so that they can manage a small paycheck reduction or join when they next get a raise, experts suggest.

Los Angeles Times Articles