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By Ellen Hoffman As of Jan. 1 -- effective for the 2002 tax year -- virtually every American has greater incentive to sock away more money for retirement. Tax-code changes signed into law last year provide higher contribution limits for all participants in 401(k) or similar tax-deferred retirement accounts, as well as for IRAs.
If you have a 401(k), a 403(b) plan (for employees of nonprofits), or a 457 plan (for state and local government employees), you may contribute up to $11,000 this year, an increase of $500 over the 2001 limit. If you're over 50, Uncle Sam will allow you to contribute an additional $1,000 as a "catch-up" contribution.
IRA contribution limits also increase in 2002, to $3,000 per person, with an extra $500 catch-up payment allowed for those 50 and older. For details on these and other retirement-related tax changes going into effect this year, see The Seeds of Change, a publication on the Deloitte & Touche Web site.
LEAN TWILIGHT? Given the stock-market gyrations of the last year and the general economic malaise, these incentives are well-timed. "Anything we can do to try to give people an inducement to save more for retirement is a plus," says Bob Barry, a Hackettstown (N.J.) financial planner who's the president of the Financial Planning Assn.
The "2001 Retirement Confidence Survey" by the Employee Benefit Research Institute and the American Savings Education Council, both nonprofits, found that the percentage of people who say they're confident that they'll have enough money to live on in retirement slipped from 72% in 2000 to 63% in 2001. Compared to last year, the number of people who are saving for retirement, as well as the number who have tried to calculate their financial needs for retirement, have also declined.
So who should be taking advantage of the new retirement-savings options, and what's the best way to do it? Here's a summary of tips offered by several financial planners:
Ask your employer to raise your plan's contribution limits. The new $11,000 limit is the maximum you can save, but an employer isn't obligated to allow you to save that much. Persuading your employer to change the plan's rules could take months of lobbying, but it's worth a shot.
Make a year-long savings plan. Decide now how much -- or how much more -- you can afford to save, whether in an IRA or an employer-sponsored retirement account, and have the new amount withdrawn each month. That way, you won't have to scramble for the cash to max it out at the end of the year. And your money will have more time to grow.
Don't save more than you really can afford. In this slow economy, fraught with the possibility of layoffs, some people simply can't afford to max out retirement savings. Barry suggests you make sure that your cash flow will be enough to pay the bills and cover emergencies before you stretch to add more feathers to your retirement nest. Except for special cases, such as financing a new home or setting up a special long-term plan under IRS rules, withdrawing money from retirement accounts before you turn 59 1/2 socks you with income tax and a 10% withdrawal penalty.
Be honest and disciplined when determining how much you can afford to save. Of course you need to leave yourself enough to pay your bills and cover your expenses. But do you really need a more expensive car or to take an exotic vacation?
Rebalance and diversify your 401(k). The Enron disaster offers a potent lesson for employees who naively assume that whatever they put into their 401(k) will at least maintain its value, if not appreciate, until they retire. Many Enron employees had the bulk of their retirement money in company stock and watched it become virtually worthless in a matter of days.
Analyze your current holdings. Experts suggest that if company stock accounts for more than about 10% or 15% of the total value of any retirement account, you should consider cashing some of it out and investing in other vehicles. Also, if your employer offers a pension plan that relies heavily or exclusively on the company's own stock, you might want to consider putting even less of your 401(k) money in the company's stock.
If your retirement is near, take a hard look at the potential tax consequences. It's possible that you could have too much money in retirement accounts, says Robert B. Walsh, a CPA and financial planner in Jersey City, N.J. "Many people go into retirement IRA-rich and cash-poor," he says. "People are often surprised that with Social Security, maybe a pension, they will be in the same tax bracket when they retire as when they were working."
Should you think you could end up in this situation, rethink maxing out a retirement account, and instead, build up a cash reserve that will cover your living expenses and help you ride out market dips during your first couple of years of retirement, says Walsh. Alternatively, Barry suggests, you can invest the money in a regular brokerage account, and when you take it out, you'll pay capital-gains tax of 20% instead of the higher income tax rate.
Plan, plan, plan -- and monitor. You can't assume that either cash flow or retirement accounts will take care of you -- especially if you don't take care of them.
Doing all this may seem overwhelming, and if that's the case, you should find a professional to help you. Learn about how to find and work with a reputable financial adviser by reading "When It's Time to Pick a Planner" (BW Online, 4/19/01). Hoffman writes Your Retirement twice a month, only for BusinessWeek Online. She is the author of The Retirement Catch-Up Guide and Bankroll You Future Retirement with Help from Uncle Sam, and you can contact her through her Web site, retirementcatchup.com