Post by Zoinkers on Sept 4, 2006 23:32:36 GMT -5
by Laura Rowley
August 25, 2006
The pension bill signed by President Bush on Aug. 17 will encourage employers to automatically enroll workers in 401(k) retirement savings plans. That means you'll now have to opt out instead of opting in.
It's a change that's long overdue. Last year, 64.4 percent of eligible employees participated in 401(k) programs managed by Fidelity Investments -- a decline of 1.1 percentage points from 2004.
Automatic for the People
It's a different story among companies with automatic-enrollment (AE) plans: Participation rates of newly eligible workers at firms with AE plans was 22 percent higher than at companies that didn't offer auto-enrollment.
The vast majority of these eligible workers are new hires, a Fidelity spokeswoman says, so the boost in participation among AE plans was greatest among younger and lower-compensated employees.
Meanwhile, of the nearly 100,000 employees automatically enrolled in a 401(k) plan last year, 87 percent stayed in the plan throughout the year, and 18 percent increased the percentage of salary they contribute.
(Fidelity, the largest provider of workplace retirement savings plans, examined 9 million participants in nearly 12,000 corporate defined-contribution plans for its annual report on the state of 401(k) investing.)
Contributing Factors
While the mechanics of investing in a 401(k) can be puzzling to many people, they're not as important as you would expect.
A recent study found that the most important factor in retirement wealth is how much an individual contributes to the plan. Putnam Investments compared three facets of a retirement savings plan over 15 years: the performance of the investments; the asset allocation; and the amount contributed by the employee.
The impact of mutual fund performance was minimal. Assuming investors had a crystal ball and chose funds they knew would perform in the top quartile, the study found their nest eggs would rise by just 6 percent. As for allocation, shifting the portfolio from conservative to more aggressive investments boosted results by a more significant 20 percent.
But the most critical factor was the one over which employees had the most control -- their contribution rates. A 2 percentage point increase (from 2 to 4 percent of income, for instance) doubled retirement wealth, and had 90 times the impact of shifting from funds performing in the bottom quartile to those in the top quartile. (Using data from Lipper, the research examined the period from Jan. 1, 1990, to Dec. 31, 2004.)
Clearly, you'll have a better shot at accumulating a decent nest egg if you start early.
A Case Study
To demonstrate this, I asked Fidelity to run some numbers for me on two guys I'll call Phil Smith and Sam Jones.
Say both men get jobs right out of college at age 22, earning $28,000 a year. Both get raises of 3 percent every year. But Phil's company auto-enrolls him in the 401(k) plan at 22, contributing 3 percent of his salary to the plan. Sam waits until he's 30 to join his plan, and also contributes 3 percent of his salary a year.
Both earn an average of 8 percent on their savings each year. At age 65, Phil has $401,146. Sam's nest egg is nearly $100,000 less -- $314,406.
Remember the original premise, though: It's the contribution rate that counts. Consider what Phil and Sam would have if they increased the percentage of salary they contributed by 1 percent every year until they maxed it out, and then remained at that contribution level until they retired. (At some companies, employees can do this automatically by choosing an "auto-escalation" option.)
Phil would be enjoying his golden years in a beach house with a kitty of $2,356,933. Sam, however, would be sleeping on Phil's couch, trying to conserve his nest egg of $1,342,914.
The Real World
OK, time to get real here. I can count on one hand the number of my peers who have remained at the same company they joined out of college. By my late 30s, I'd worked full-time for five different firms before going out on my own to gain more flexibility.
Let's consider what would happen if Sam and Phil had both left their companies at age 37. Maybe they get downsized, or decide to stay home with the kids, join the Peace Corps, or open a winery in Napa. In any case, they never contribute to a retirement plan again.
If their portfolios average earnings of 8 percent a year, at age 65 Phil's savings would be worth $234,024; Sam's would be less than half of that -- $111,260. They obviously wouldn't have enough to retire on, but the savings would help.
Now let's combine the scenarios -- the men leave their jobs at age 37, but instead of contributing just 3 percent of their salaries while at the company, they increase them by 1 percent a year. Phil, who joins the plan at age 22, will have a nest egg of $718,332. Sam's nest egg? A paltry: $164,542.
The magic of compounding means Phil will have a decent cash cushion and flexibility in retirement -- and more important, the option of making a lifestyle change in his 30s that makes him happy. Sam, meanwhile, will likely be in the workforce many more years than he had banked on, and may feel stuck in a job he hates.
Save Early and Often
Phil and Sam could do even better by choosing an employer that matches a portion of their contributions and investing aggressively from day one. The easiest way to do this is to choose a life-cycle or target-strategy fund, which allocates a worker's savings among both stock and bond funds based on age.
The fund gradually shifts to more conservative investments as the employee gets closer to retirement. Among plans administered by Fidelity, 83 percent offer at least one life-cycle fund option, and about one-quarter of participants choose these funds.
The bottom line? Start early, and contribute as much as you can. The longer you wait, the more painful the level of contribution required, and the less opportunity you'll have to enjoy compounded growth. The sooner you start, the more flexibility you'll have in your 40s, 50s, and beyond.
August 25, 2006
The pension bill signed by President Bush on Aug. 17 will encourage employers to automatically enroll workers in 401(k) retirement savings plans. That means you'll now have to opt out instead of opting in.
It's a change that's long overdue. Last year, 64.4 percent of eligible employees participated in 401(k) programs managed by Fidelity Investments -- a decline of 1.1 percentage points from 2004.
Automatic for the People
It's a different story among companies with automatic-enrollment (AE) plans: Participation rates of newly eligible workers at firms with AE plans was 22 percent higher than at companies that didn't offer auto-enrollment.
The vast majority of these eligible workers are new hires, a Fidelity spokeswoman says, so the boost in participation among AE plans was greatest among younger and lower-compensated employees.
Meanwhile, of the nearly 100,000 employees automatically enrolled in a 401(k) plan last year, 87 percent stayed in the plan throughout the year, and 18 percent increased the percentage of salary they contribute.
(Fidelity, the largest provider of workplace retirement savings plans, examined 9 million participants in nearly 12,000 corporate defined-contribution plans for its annual report on the state of 401(k) investing.)
Contributing Factors
While the mechanics of investing in a 401(k) can be puzzling to many people, they're not as important as you would expect.
A recent study found that the most important factor in retirement wealth is how much an individual contributes to the plan. Putnam Investments compared three facets of a retirement savings plan over 15 years: the performance of the investments; the asset allocation; and the amount contributed by the employee.
The impact of mutual fund performance was minimal. Assuming investors had a crystal ball and chose funds they knew would perform in the top quartile, the study found their nest eggs would rise by just 6 percent. As for allocation, shifting the portfolio from conservative to more aggressive investments boosted results by a more significant 20 percent.
But the most critical factor was the one over which employees had the most control -- their contribution rates. A 2 percentage point increase (from 2 to 4 percent of income, for instance) doubled retirement wealth, and had 90 times the impact of shifting from funds performing in the bottom quartile to those in the top quartile. (Using data from Lipper, the research examined the period from Jan. 1, 1990, to Dec. 31, 2004.)
Clearly, you'll have a better shot at accumulating a decent nest egg if you start early.
A Case Study
To demonstrate this, I asked Fidelity to run some numbers for me on two guys I'll call Phil Smith and Sam Jones.
Say both men get jobs right out of college at age 22, earning $28,000 a year. Both get raises of 3 percent every year. But Phil's company auto-enrolls him in the 401(k) plan at 22, contributing 3 percent of his salary to the plan. Sam waits until he's 30 to join his plan, and also contributes 3 percent of his salary a year.
Both earn an average of 8 percent on their savings each year. At age 65, Phil has $401,146. Sam's nest egg is nearly $100,000 less -- $314,406.
Remember the original premise, though: It's the contribution rate that counts. Consider what Phil and Sam would have if they increased the percentage of salary they contributed by 1 percent every year until they maxed it out, and then remained at that contribution level until they retired. (At some companies, employees can do this automatically by choosing an "auto-escalation" option.)
Phil would be enjoying his golden years in a beach house with a kitty of $2,356,933. Sam, however, would be sleeping on Phil's couch, trying to conserve his nest egg of $1,342,914.
The Real World
OK, time to get real here. I can count on one hand the number of my peers who have remained at the same company they joined out of college. By my late 30s, I'd worked full-time for five different firms before going out on my own to gain more flexibility.
Let's consider what would happen if Sam and Phil had both left their companies at age 37. Maybe they get downsized, or decide to stay home with the kids, join the Peace Corps, or open a winery in Napa. In any case, they never contribute to a retirement plan again.
If their portfolios average earnings of 8 percent a year, at age 65 Phil's savings would be worth $234,024; Sam's would be less than half of that -- $111,260. They obviously wouldn't have enough to retire on, but the savings would help.
Now let's combine the scenarios -- the men leave their jobs at age 37, but instead of contributing just 3 percent of their salaries while at the company, they increase them by 1 percent a year. Phil, who joins the plan at age 22, will have a nest egg of $718,332. Sam's nest egg? A paltry: $164,542.
The magic of compounding means Phil will have a decent cash cushion and flexibility in retirement -- and more important, the option of making a lifestyle change in his 30s that makes him happy. Sam, meanwhile, will likely be in the workforce many more years than he had banked on, and may feel stuck in a job he hates.
Save Early and Often
Phil and Sam could do even better by choosing an employer that matches a portion of their contributions and investing aggressively from day one. The easiest way to do this is to choose a life-cycle or target-strategy fund, which allocates a worker's savings among both stock and bond funds based on age.
The fund gradually shifts to more conservative investments as the employee gets closer to retirement. Among plans administered by Fidelity, 83 percent offer at least one life-cycle fund option, and about one-quarter of participants choose these funds.
The bottom line? Start early, and contribute as much as you can. The longer you wait, the more painful the level of contribution required, and the less opportunity you'll have to enjoy compounded growth. The sooner you start, the more flexibility you'll have in your 40s, 50s, and beyond.