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In your 50s: Playing catch-up
There's still time -- here's how to use new tax laws to your advantage.
April 27, 2005: 11:24 AM EDT
By Penelope Wang, Laura Lallos & Walecia Konrad, Money Magazine
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NEW YORK (Money Magazine) - If you're in your 50s or early 60s, preparing for retirement can be a schizophrenic pursuit.

You need to invest aggressively enough to make up for any losses or lack of planning, yet conservatively enough to preserve the wealth you've accumulated so far. That tug and pull is even more pronounced in this market.

But even if you've lost ground, now is not the time to be overly aggressive. "People in their 50s and 60s can't afford to take huge risks this close to retirement, no matter how far behind they may feel," says Robert Bingham, founding partner of San Francisco wealth-management firm Bingham Osborn & Scarborough.

So how do you meet your needs? The answer is careful planning. Here's how to go about it.

"Catch up" in your 401(k). The catch-up provisions in the 2001 tax law are designed for vigorous savings. And they're quite a bonus. For 2003, employees 50 and older can save an additional $2,000 in their 401(k), 403(b) or 457 plans, on top of this year's $12,000 contribution limit for all workers.

That catch-up amount increases each year until 2006, when employees 50 and older can stash a total of $20,000 in their workplace plan, $5,000 above that year's contribution limit for all workers. Beyond 2006, both the standard limits and the catch-up provisions for all plans will be adjusted annually for inflation.

The 2001 tax law also increases the limits on the pretax dollars that can be put into your plan. The new rules now allow your retirement contributions plus your employer's match and other pre-tax benefits such as profit sharing to total a maximum of 100 percent of compensation or $40,000, whichever is less.

For two-earner couples trying to catch up, this may allow one spouse to put away a huge chunk of his or her salary for retirement. (As with all the new contribution rules, you can take advantage of the catch-up provisions only if your employer has agreed to offer them.)

Even with a relatively short 15-year time frame, that extra stash can make a big difference. If you put away the additional sum every year beginning at age 50 and earn an 8 percent annual return, you could boost your nest egg by more than $200,000 before taxes, according to T. Rowe Price.

"Catch up" in your IRA. Older workers also can make more generous IRA investments. This year, the maximum contribution to all types of IRAs is $3,500 for anyone 50 or older, $500 above the $3,000 limit for everyone else. The IRA cap increases over the years, reaching $6,000 for those 50 and older in 2008.

That means if you are able to take full advantage of the catch-up rules in your 401(k) and your IRA, you'll be able to put away $17,500 in 2003 tax-deferred; by 2008, that number will be $26,000.

The bottom line? If you're a 50-year-old and can fully fund both accounts, you can retire with an estimated $300,000 more than you could have saved tax-free before the 2001 tax-rule changes.

Consider working more. Saving more is the obvious first step if you've undergone some devastating stock market losses and think you'll fall far short of your retirement goal.

But there's another option: working longer. It's a choice more and more employees are considering. According to a survey of high-income investors by Quicken.com, 13 percent of respondents said they are planning to retire later than they originally intended, and more than one-third of those said they would work five extra years or longer.

Assuming you can stay at your job and continue to contribute to your firm's retirement plan, just five extra years of pouring the maximum into your 401(k) can add almost $100,000 to your portfolio, assuming an 8 percent annual return, according to T. Rowe Price. Staying at work when you thought you'd be off seeing the world could mean a major adjustment, but numbers like that might make the delay worthwhile.

Merge plans. In addition to the higher contribution caps, there are some other less-publicized tax-code changes that, indirectly, could help savers who are trying to make up for lost money or lost time.

The new rules make retirement money more portable than ever. And that's especially important later in your career, when job changes may have left you with multiple retirement accounts scattered among different corporate benefits departments and financial institutions.

Now you'll be able to consolidate more of these accounts, making them easier to track and manage. And if you have money trapped in a plan with high fees or poor investment choices, it's now more likely that you can liberate it.

You now are allowed to roll all 401(k), 403(b) and 457 accounts from previous jobs into an IRA or your current employer's plan if the company permits. And IRAs may be rolled into company-sponsored plans -- again, if the plan allows.

The new rules are especially good for government employees with old 457 plans, which formerly could not be rolled over into another 457, 401(k), 403(b) or IRA.

After-tax nondeductible contributions in a qualified plan such as a 401(k) may be rolled over to another qualified plan or IRA only if the plan provides separate accounting for such contributions.

Invest for stability. Once you've consolidated your accounts and upped your savings, one question remains: What's the best way to invest at this stage? If you've suffered big losses, the temptation may be to try for a big, fast payoff. But now is the time for thoughtful diversification and a steady hand.

Once you hit your fifties you'll want to diversify your equity holdings among growth and value, small-caps and large-caps and international stocks. In addition, you should gradually move more toward a 35 percent allocation in a variety of fixed-income investments.

As you rejigger your portfolio, you may want to sell some of your underperforming stocks and funds, especially if you've lost faith in them, and use that money to finance fresh retirement savings. The silver lining? When you sell stocks or funds at a loss in your taxable accounts, you'll be able to offset any capital gains you've realized in that account during the same year, and write off up to $3,000 in remaining losses against ordinary income.

It's important to diversify your fixed-income holdings as well. To do that, consider stable-value funds to complement your individual bonds and bond funds. These fixed-income funds typically deliver returns equivalent to intermediate-term bond funds, with the stability of money-market funds. They are offered in most 401(k)s, although they may be called by another name, such as a capital-preservation fund or income fund. Stable-value funds invest in guaranteed income contracts -- which promise a rate of return for a specified length of time, usually 2-1/2 years -- and also hold high-quality bonds and other interest-paying vehicles.

Over the 1-year period ending Jan. 31, 2003, stable-value funds averaged a return of 5.54 percent. Typically, these funds fluctuate less than one-quarter of one percentage point a year, thus living up to their name.

Bail out of company stock. When you're looking at allocations, be sure to add up what portion of your portfolio is in company stock. After Enron, no one needs a reminder of just how risky heavy exposure to your employer's stock can be. Fortunately, age 50 or 55 is usually the time most corporations allow employees to start reallocating company stock held in their retirement plans.

"Be sure to look at your 401(k), but also any company stock you might have in employee-purchase plans or incentive stock options," says Donn Sharer, a vice president at MetLife financial services. "It's easy to ratchet up your position in company stock to the point where it accounts for more than half of your net worth." If that's the case, now is the time to get out.

(This article, originally published in the April 2002 issue of Money Magazine, has been updated.)  Top of page

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