Many retirement investors have left the markets and stopped participating in their 401(k) plan in the past two years because they fear more losses. I don’t blame folks for being nervous about the volatility of the stock and bond markets. On the other hand, when you stop contributing to your 401(k) retirement account, you miss out on valuable tax deferral benefits.
There is a simple two-step method for using a 401(k) plan to provide a guaranteed investment return of up to 50 percent without exposing your retirement contributions to meaningful risk.
Step 1: Contribute to your 401(k) account at the level necessary to capture the full amount of your employer’s matching contribution. Then stop.
Step 2: Allocate all of your contributions and your employer’s match to a stable value fund.
This method assumes that your employer has not stopped matching 401(k) contributions and that your plan uses one of the most typical matching features.
Many 401(k) plans use a fixed match. The most common match formula is a 50 percent match up to the first 6 percent of employee income. Other popular matches include a dollar for dollar match up to the first 3 or 4 percent of income. If your employer uses one of these matching formulas, this two step plan can work for you. All you need to do is calculate how much you need to save to capture all of your employer’s matching dollars and automatically contribute that amount through payroll deferrals.
The second step is important to provide a guaranteed return. Most 401(k) plans offer a stable value fund as one investment option. The typical return from a stable value fund may be only 2 to 4 percent but the benefit is that you are mostly assured of not losing money. This assurance exists because stable value funds use an insurance wrapper that protects and guarantees the asset values in the fund.
To see how the two-step method works, assume that your annual income is $75,000. Let’s further assume that your employer matches 50 percent of your 401(k) contributions up to 6 percent of your income. If you contribute $4,500 (6 percent of $75,000), your employer will match that with $2,250 (50 percent of your $4,500). Finally, you direct your 401(k) plan administrator to place all of the $6,750 (your contributions plus the employer match) in your plan’s stable value fund.
At the end of the year you will have a total of $6,750 credited to your retirement account, from your investment of only $4,500. You may even have closer to $6,950 in your account, assuming a 3 percent return from the stable value fund. You will have earned a 53 percent return from your retirement account while taking on virtually zero risk. And that’s not even counting the important tax deferral benefits of saving for retirement using a 401(k). This is a return that you are unlikely to get anywhere else.
Mark Patterson is an engineer, patent attorney, baby boomer, and author of The Failsafe Retirement System. He blogs on matters of personal finance and retirement planning at Tough Money Love and Go To Retirement.