5 Tips to Improve your 401(k) Plan

Last year I interviewed a 54-year-old woman who planned to retire at 62 and felt she was on track to do so. She had been contributing 10% of her biweekly pay into her 401(k) since 1984, but when I asked her what her retirement savings goal was, how much she had already amassed in her 401(k) or how much she anticipates she’ll need to live on in retirement, she didn’t know.

She said, “I couldn’t tell you how much is in there or what I’m invested in. I’m working hard now to pay off my mortgage so I won’t have that expense after I retire, but I don’t know if what I saved will be enough. I just know that I’m saving toward retirement and I thought that would be good enough.”

Like her, millions of Americans put their 401(k) plans on autopilot, have limited knowledge about how and where their funds are invested, and are not even aware that they’ll experience an asset shortfall when the time comes to retire.

Taking the time to set up a good strategy and plan for your retirement can be your best ally. A lousy plan could destroy your chance of a decent and secure retirement, notes Clyde Anderson, a financial lifestyle coach.

Here are some tips and resources to help you determine how well you have prepared and what you can do to improve your retirement outlook.

1. Determine your needs

The rule of thumb is that you’ll need about 70% to 80% of your pre-retirement income to live on in retirement, depending on your lifestyle. Get a snapshot of your current lifestyle or “bank statement bio.” This means looking at the last 12 months of bank statements to identify what you currently spend your money on. Next, separate your spending into categories such as housing, entertainment, and meals. (Programs such as Mint.com will do this for you.) You will have to project what expenses you will no longer have come retirement and which ones will remain the same or increase, notes Anderson.

Check out this pre-retirement calculator from Yahoo! Finance to see if you’re on the right track.

2. Do the math

While they may differ for everyone, there are three areas that are crucial to determining how much money you will need in retirement:

A: Your current age, current annual income, current take-home pay, and current monthly expenses. Don’t forget about variable costs such as recreation, home improvements, and vehicle repairs.

B: Your goals. What age would you like to retire? How much retirement income would you like to have? Will your current salary be your goal or will a fraction of that amount suffice?

C: Your projected life expectancy. Most calculators assume age 90. If you retire at 65, you may live another 20 or 30 years. Also, take into account what your projected annual pension (if applicable) and expected Social Security payments will be.

For example, a 50-year-old earning $80,000 a year and planning to retire at age 65 will need an estimated $2 million to last them about 30 years in retirement if they plan to live on 70% of their former income. This is in addition to their expected monthly Social Security benefit.

After reviewing each of these areas, write down your anticipated monthly income in retirement that will come from a pension, Social Security, and 401(k)/IRA withdrawals. If this number is close to your current take-home pay, you may be in good shape. But if it isn’t you, have four choices: 1) spend less in retirement; 2) save more money; 3) push back your retirement timeframe; or 4) earn a higher rate of return on your investments. You will need to make up the gap between how much you need to retire and the amount provided by guaranteed sources of income. Don’t forget to account for inflation in your calculations.

Use this calculator from FINRA to plan your investing strategy now so that you will have enough to see you through your retirement years.

Also check out ING’s retirement needs calculator to help you put some concrete expectations to your retirement lifestyle.

3. Don’t set it and forget it

Be actively involved when it comes to your retirement account. The asset allocation that you set when you first started working and began investing will need to be adjusted. Meaning, you want to diversify your 401(k) by allocating your investments among different asset classes, which include stocks (large-cap, small-cap, growth, international, etc.), bonds, cash, and real estate investment trusts (REITs). Since different asset classes react in different ways to changing market conditions, the right asset allocation mix according to your risk tolerance and retirement time horizon can possibly increase your potential for better returns. For instance, you may have less of your retirement funds allocated to stocks as you get closer to retirement age, as the risk of losing money increases with less time to recoup from losses.

4. Rebalance

There are two general approaches to when you should rebalance your 401(k) account. One is to rebalance on a regular time schedule, such as quarterly, semi-annually, or annually. The other approach is to rebalance when the allocation is a certain number of percentage points away from its target due to the difference in performance between funds in your 401(k) account over time. For example, a 401(k) participant with a 50% stocks, 50% bonds target allocation might rebalance when stocks are more than 55% or less than 45% due to changing market conditions. You need to closely monitor fund balances in your account for this approach, comparing ending balances to the target allocation for each fund. To rebalance means to sell enough of the funds above your target and buy enough of the funds that are below your target.

5. Read your statements

“Not looking at your statement is like throwing money away,” says Anderson. “These statements contain a lot of information and plenty of numbers, so it can be all too easy to just look at the bottom-line figure and ignore everything else.”

Some key things to pay attention to are your expense ratio and fees for each mutual fund in your account. Did you know that just 1% in fees and expenses reduces your account balance at retirement by 28%, eating away at your returns? If you find you are paying more than 1% a year in expense ratios or high fees, you need to get an explanation from your 401(k) manager, and consider possibly moving your money to another fund.

Need a boost? Enter our Financial Fitness Contest for a chance to win $2,000 and a one-hour session with a certified financial planner.