401k Planning: Tips to Keep Your Retirement Plan on Track

March 2, 2011— -- As the baby boomers approach retirement age, the generation that came to widely rely on the 401(k) is finding itself unprepared for their financial future. According to a new study, the median household headed by someone 60 to 62 has less than a quarter of what they need for retirement. That's a terrifying number.

Mellody Hobson, president of Ariel Investments and "Good Morning America" personal finance contributor, appeared on the show this morning to answer the following questions and provide tips to help you stay on track for your retirement.

Q: About 60 percent of households nearing retirement age rely at least in part on 401(k )plans. Why aren't those plans enough?

When 401(k)s were first introduced, they were meant to be a retirement supplement, but they have now evolved into a full retirement solution. Baby boomers, the people who are retiring now, were the first generation to be exposed to 401(k)s. They got a late start. Even if they started using them from the day 401(k)s were first used in 1981, some still would have started at around age 35, which means their contributions have not had that much time to benefit from compounding.

A second reason 401(k)s may appear as though they are not doing the job is because people are not saving enough. The average worker currently contributes about 8 percent of their income in their 401(k)s. So if you make $50,000, that is only about $4,000 a year, which is way too low. Retirement accounts have also been hard hit by the recession. This has led to loans and hardship withdrawals for some. So people are taking assets out, and they are not growing at a flat return. This is important because equities should be the fastest way to build a portfolio.

Q: If you've fallen behind on retirement savings what can you do now?

The most important thing you can do is work longer, even if only part-time. You will also need to save more. Working and saving more will help you reap a greater benefit from the power of compounding.

Also, delay taking Social Security, she said.

If a person is entitled to full benefits when they are 66, and if they start withdrawing at 62, then they will only receive 75 percent of their benefits. But if they wait until they are 70, then they would get 32 percent more than their full benefits.

Plus, you can catch up on your 401(k) savings. The government wants to help older individuals who got a late start on their 401(k) savings. If you are below 50 you can contribute up to $16,500, but if you are over 50, there is a catch-up provision which allows you to put another $5,500 in your 401 (k) for a total of $22,000. Definitely try to take advantage of this, Hobson said.

Q: Health care costs are rising. How should that affect retirement planning?

Health care costs are rising at an astronomical rate for people of all ages. A study by Fidelity Investments found that retiree healthcare expenses rose by 4.2 percent in 2010, and they have gone up by 56 percent since 2002. Another study by Aon Hewitt found that in the past 10 years health care premiums have doubled and the employee's share of medical costs have tripled during that same time period.

So this will obviously affect how much you need to save. Advisors used to say you need to make 85 percent of your working income in retirement. Hobson advised that you need 100 percent. The 85 percent rule was adequate when the housing market was stable and health care costs were manageable. With the housing issues many individuals have, skyrocketing medical costs, and the fact that people are living longer, the 85 percent rule is outdated, she said.

So now the most conservative way to think about it is that you need 100 percent. The best thing that could happen is that your money outlives you. The worst is that you outlive your money.

Q: How early do you have to start saving for retirement? I'm thinking of recent grads, people trying to pay off student loans. Do you pay off your loans, or save for retirement?

Hobson said you should start saving for retirement as soon as possible.

The sooner you start saving, the more time your money will have to grow. You can never make-up for these lost years. She suggested putting away some money for your retirement and also gradually paying off your student loans.

The same goes for your child's education loans. I don't think it is ever a good idea to sacrifice your retirement money to pay off someone else's debt. I know that as parents you may be inclined to help your children out, but remember you have a limited number of years left to earn and save your money, and your children have a lifetime to pay off their loans and save for their own retirement, she said.

Web Extra Tips

Here are some more of Mellody's tips:

• If you cannot contribute the maximum amount, make sure you at least contribute up to the company match level. This is basically free money they are giving you.

• Think of a loan from your 401(k) account as a last resort. The amount you take out will not grow in your account. Also, if you lose your job for any reason, you will have to pay back the loan in a short amount of time, or face penalties and taxes.

• If you are moving to a new job, rollover your 401(k) to your new employer. Keeping your 401(k) at one place will make it easier to manage your money. If you do not like the choices at your new employer, then roll it over to an IRA at one at a brokerage.