Editor's note: The following is adapted from "We're not in Kansas anymore: Strategies for retiring rich in a totally changed world," by Walter Updegrave, senior editor at Money magazine.
Following these 10 steps can't guarantee that you'll end up with a 401(k) large enough to fund the retirement of your dreams. But it can certainly increase the odds in your favor.
1. Sign up for your plan ASAP.
Granted, when you're young and starting a new job, retirement may seem like some misty mirage on a distant horizon. But getting started just five years late can reduce the eventual size of your retirement nest egg by 25% or more. So if you're eligible for your company's plan, sign up today.
2. Contribute as much as you possibly can.
Stashing away the maximum may mean reining in your current standard of living a bit. But remember: The more you contribute now, the better the standard of living you'll enjoy in retirement.
3. If you can't max out, contribute at least enough to get the employer's match.
Not taking advantage of your employer's matching contributions—often 50% of what you put in—is like walking away from free money. If you can't contribute enough to get the full match, at least invest enough to take advantage of some of your employer's largesse.
4. Take advantage of catch-up contributions
If you're 50 or older, you can boost the wealth-building potential of your 401(k) even more by taking advantage of the 2001 tax law's catch-up provisions. You can contribute up to $3,000 in addition to regular contributions in 2004 and as much as $5,000 extra by 2006. This is an excellent way for procrastinators to jump-start the value of their retirement accounts.
5. Allocate your 401(k) assets wisely.
The key is finding the right balance between stocks and stock funds—which provide long-term growth and keep the purchasing power of your nest egg ahead of inflation—and bonds and other income investments that offer more stability. There's no one-size-fits-all solution to this issue, but generally the higher your tolerance for risk and the longer you have until retirement, the more you should tilt the balance toward stocks and stock funds.
6. Factor in costs.
When choosing investments for our 401(k), we tend to focus on returns. But choosing investments with low expenses can boost the size of your nest egg considerably. To learn more about 401(k) fees, check out the Pension Welfare Benefits Administration's online booklet, "A Look At 401(k) Fees For Employees," which is available at the Department of Labor's Web site. If your 401(k) offers retail mutual funds, you can check out their expenses at Morningstar.com.
7. Don't raid your 401(k) before retirement.
The more often you tap your 401(k) before you retire, the less money you're likely to have available in your account when you retire. So rely as much as possible on other investments to get you through hard times, and tap into your 401(k) only in true emergencies, and only after you've exhausted other resources.
8. Eliminate between-job "leakage."
An estimated two-thirds of workers who change jobs simply cash out their 401(k) balances rather than roll the money over into another tax-deferred plan to keep it growing for retirement. A better plan: Roll your 401(k) balance into your new employer's plan or into an IRA rollover account. This way you'll avoid being hit with income taxes and you'll continue to rack up tax-deferred gains.
9. Don't overdo it on company stock.
The more company stock you own, the greater the risk you're taking with your retirement. In general, you should limit company-stock holdings to no more than 10% of your 401(k). If you hold more than that percentage—either because you want to or because company restrictions prevent you from paring your stake—be sure to diversify the rest of your portfolio in a way that compensates for your concentration in company shares.
10. Monitor your account regularly.
You don't have to devote every waking moment to tracking your 401(k), but you do want to monitor the performance of your investments occasionally. And give your 401(k) portfolio a thorough check-up at least once a year. Keep tabs as well on any changes to your plan, including new investment options and increases in the contribution limit or company match.