Six Simple Ways to Retire Rich

Thanks to automatic 401(k) plans and one-stop investing options, saving for retirement is a cinch.

By Mary Beth Franklin, Senior Editor

From Kiplinger's Personal Finance magazine, February 2008

Retirement savings plans are undergoing an extreme makeover. After decades of trying to teach Americans how to save and invest for their own retirement -- with mixed success -- employers have come up with a simple solution: They'll do it for you.

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Thanks to automatic enrollment in 401(k)s and other retirement plans, plus streamlined investment options, saving is so effortless that you can't help but succeed. And that's true whether you're starting your career, switching jobs or planning your exit.

To help their employees compensate for disappearing pensions and declining Social Security benefits, more than one-third of large companies have already embraced the new reality of retirement saving: the automatic 401(k). That's up from just 19% in 2005.

More than half of all employers expect to offer automatic enrollment this year. The trend also applies to 403(b) retirement plans for teachers and employees of nonprofit organizations, as well as to the 457 plans that many state and local governments use. "Now you'll succeed at saving for retirement even if you don't do anything," says Jeff Maggioncalda, president of Financial Engines, a pioneer in providing investment advice to workers.

The most effective new plans pair automatic enrollment with an option to increase the amount you contribute to your account each year. When Nationwide Insurance added an automatic-escalation feature to its 401(k) plan last spring, employees Sean and Lisa Kennedy signed up, promising to boost their contributions by one percentage point each year until they reach the maximum contribution level.

"We can tie it to our annual salary increases," says Sean, 38. "We'll never see the extra money in our take-home pay, so we won't miss it."

Aside from adding to their already substantial nest egg, the Kennedys will also be able to cut their taxes -- a more immediate concern, says Lisa, 31. She and Sean, who live in Columbus, Ohio, contributed more than $25,000 to their retirement accounts in 2007, saving them more than $7,500 in taxes, assuming a combined state and federal rate of 30%.

The third piece of the automatic 401(k) model is built-in professional investment advice, whether in the form of target-date retirement funds, computer-generated model portfolios or managed accounts. Together, the changes amount to a total overhaul of 401(k) plans. "It reverses our assumptions about what individuals are willing and able to do," says Maggioncalda. "It makes inertia work in their favor."

1. Sign Up

Employees are nearly unanimous in their support for being automatically enrolled in their company's 401(k) plan, according to a recent study conducted for the Retirement Made Simpler coalition, made up of AARP, the Financial Industry Regulatory Authority (Finra) and the Retirement Security Project. Nearly 95% of surveyed adults agreed that auto 401(k) plans make saving for retirement easier, and 85% said they started saving earlier as a result. Only 7% of those who had been automatically enrolled in a plan opted out. (If you are automatically enrolled in your company plan, you can get your money back without tax penalty if you back out within the first 90 days.)

Although auto 401(k) plans are a major step forward, they have a downside. Pamela Hess, director of research for consulting firm Hewitt Associates, worries that some employees may be lulled into complacency, accepting default contribution levels as implicit savings guidelines when they can and should be saving more. Most employers set the initial deferral rate at 3% of salary, and many plans with automatic-escalation features top out at 6% of pay. That's well below the 15% of gross income (including employer matching contributions) generally recommended as a target for retirement savings.

The Kennedys, who are approaching that recommended 15% target, are well on their way to a secure retirement, even if their plans to start a family may force them to scale back future contributions. An early start on saving, coupled with the power of compounding, will work its magic over time. But if you're a late bloomer, don't despair. By starting now and increasing your contributions a little each year, you could still reach your goal.

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