Repair, Rebuild, Retire

The storm has subsided. Now get your savings back on track and maybe prepare to work a few years longer.

If you're worried that significant cracks in your nest egg will scramble your retirement plans, you're not alone. In 2008, more than 40% of U.S. workers saw their 401(k) plan balance drop by 30% or more in the wake of the biggest market meltdown since the Great Depression. If you were temporarily paralyzed by the carnage, it's time to take charge again. After all, your peak account balance was merely a snapshot in time, not a birthright. Markets go up and, unfortunately, they also go down.

Now is the ideal time to assess your financial situation to determine whether you need to save more (you probably do); rethink how you invest your money (maybe you're not quite as risk-averse as you thought); and consider delaying retirement by a few years.

"Even modest increases in savings or delaying retirement can get your plans back on track," says Ken Fine, a vice-president with Financial Engines, a leading provider of investment advice to 401(k) plan participants. But, adds Fine, "left to their own devices, some people are making a bad situation worse."

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The inertia problem

Most workers haven't made any changes in their retirement-savings plan. A recent report by Vanguard found that 84% of its more than three million retirement-plan participants made no trades in their accounts in 2008. That inertia no doubt shielded many investors from overreacting to market volatility, but it also indicates that some are frozen in their tracks.

Because workers have sustained such extraordinary losses, "they'll need to be much more proactive about saving to build their nest egg back to prerecession levels," says Pamela Hess, director of retirement research at Hewitt Associates, a human-resources consulting firm. That means reviewing your mix of funds, rebalancing periodically and getting advice on how to meet your long-term goals.

Or you can keep it simple and use an all-in-one target-date fund, which selects and manages your investments for you and grows more conservative as you approach your retirement goal. (Congress is looking into target-date funds that suffered major losses last year during the once-in-a-generation market collapse. Nevertheless, we still believe these funds are appropriate for long-term investing goals.)

The stock allocation in the average 401(k) participant's account dropped to 59% at the end of 2008, according to a study by Hewitt. That's the lowest level since the company started tracking trends in saving for retirement 12 years ago. "Workers who impulsively transfer assets to more-conservative funds during market slumps may hurt their ability to save enough for retirement," Hess warns. (Use our calculator to see how long it will take to recover your savings.)

A new study by Financial Engines found that delaying retirement by two to three years can help meet retirement-income goals even without increasing annual savings -- assuming you maintain a diversified, age-appropriate portfolio. But those who abandoned stocks last year in favor of an all-cash portfolio face a tougher challenge. Because of the low returns on supersafe investments, some workers may have to stay on the job up to four years longer than those who maintained a diversified portfolio in order to recover from the 2008 declines.

Even so, a growing number of financial advisers are urging retirees and those nearing retirement to shift their focus from return on investment to reliability of income (see Preserve Your Income). "If you have a significant nest egg already in place, consider managing it more conservatively than the new dollars you invest in the market," says Jim Coleman, a financial planner in Waterbury, Conn.

Stay the course

Bob and Shannon Maixner of Mahtomedi, Minn., are sticking with their asset allocations. Despite a 40% drop in their retirement accounts from their peak value at the end of 2008, they haven't made any drastic changes in their investment portfolio, which is about 80% in domestic and international stock funds and 20% in bond funds. "We still have time to recover," says Bob, 43, who hopes to retire in 20 years.

A program manager for a defense contractor, Bob contributes 6% of his salary and his employer matches 3%. "That's a 50% return right there," he says. "I rode the market down, and I'm going to ride it back up." In fact, things are already looking up. Some of the funds in his IRA and 401(k) accounts delivered double-digit returns during the first half of 2009.

The Maixners also have a Plan B. Shannon, 42, launched a home-based physical-therapy practice six years ago, figuring she could squeeze in time to help clients amid the after-school activities of their three children. Since then, Fitness Focus has blossomed into an off-site boutique studio with 15 part-time employees offering physical therapy, massage therapy, nutrition consulting, and yoga and Pilates instruction. Shannon saves about 10% of her earnings in a SEP IRA. (Business owners can shield up to 25% of their salary from taxes by contributing to a SEP IRA—up to $49,000 in 2009.)

Bob keeps the books and handles the studio's finances in his spare time -- and jokes that Shannon might pay him for his services once he retires. As a former naval reservist, he's eligible for medical benefits from the military and won't have to wait until age 65 to qualify for Medicare. He'll also collect a pension starting at 60 -- something most future retirees can't count on.

Age matters

While mid-career workers such as the Maixners are optimistic about making up their investment losses by continuing to work and save for another decade or two, younger workers in their twenties and thirties should positively rejoice. Depressed stock prices following the worst ten-year U.S. market performance in history present an enormous buying opportunity. New research by mutual fund company T. Rowe Price finds that those who began investing regularly during severe bear markets in the past were significantly better off 30 years later than investors who began during bull markets because they could buy more shares at lower prices. The key is to start early. (For a decade-by-decade action plan, see Your Retirement Action Plan.)

Older workers in their fifties and sixties, however, are in a precarious position. For many, the only option is to work longer. Working longer is a powerful strategy for several reasons: It allows you more time to save, gives your investments more time to recover, decreases the number of years you need to rely on those savings, and boosts your Social Security benefits, which are worth more the longer you wait to claim them, up to age 70.

Mike Gray of Drexel Hill, Pa., plans to keep working at least a couple more years. After years of dreaming about retirement, "it's all changed in one fell swoop," says Mike, 54. He estimates his retirement account lost 30% last year despite a fairly conservative investment strategy. "I didn't take any additional risk and I didn't do anything wrong, but now I have to reevaluate my plans," he says.

A marketing manager for a Philadelphia beer distributor, Mike always assumed he'd retire at 62. He planned to play a lot of golf and maybe invest in some real estate that he could fix up and resell. Now he figures he'll work until 64 -- maybe longer. In the meantime, he and his wife, Laurie, 53, are focusing on paying down debt and delaying major purchases. But once their third child graduates from college in a few years and they pay off their mortgage, they'll have extra cash to invest for retirement.

Laurie still hopes to retire from her position as a manager at a local hospital in a few years. With 18 years under her belt and a traditional pension in her future, it's possible. That would leave her plenty of time to make good on her promise to Mike to learn how to play golf. For their 30th wedding anniversary, she bought her own set of clubs (and presented them to him in a pink golf bag as a joke). She figures that should keep them busy for the next 30 years.

While the Grays share a vision of retirement, some people are so distraught over their investment losses that they can't even talk about it. "Many couples told us that they have fewer assets, will need to delay retirement and work longer, and are worried about the impact of inflation and rising health-care costs," says Kathleen Murphy, president of Personal Investing at Fidelity. "Yet they aren't talking, planning or managing their finances jointly to address these very important issues."

In its survey of more than 500 married couples 45 and older, Fidelity found that 60% don't agree on their respective retirement ages, and 42% have different lifestyle expectations in retirement. But ignoring the elephant in the room won't make it go away.

Retirement boot camp

You may assume you'll spend less money in retirement, but you could be wrong. Some people actually spend more when they retire, at least during the first few years, as they catch up on home-maintenance projects and satisfy their pent-up desire for travel and leisure activities. The first step is to track how much you're spending now.

Marcia Tillotson and Joy Kenefick, of Wells Fargo Advisors in Charlotte, N.C., put their clients through a process they've dubbed "retirement boot camp" to let clients test-drive their retirement budget. They start with a detailed cash-flow analysis of their clients' current expenses and estimates of how those expenses will change in retirement. Then they draw up a budget and ask their clients to stick to it for a year or two. "We ask them to live on less and invest the additional savings," says Kenefick. "The exercise confirms that they are adequately prepared both emotionally and financially for retirement."

Those who flunk boot camp have two choices: stay with their original retirement timetable and learn to live on less, or work longer and save more. "Some clients hate what they do and are willing to cut their lifestyle in half to get away from their job," says Tillotson. For others, the challenge is to figure out what to do with their time once they retire.

The advisers urge their clients to maximize their 401(k) contributions and, for those age 50 or older, to take advantage of catch-up contributions—even if it means tapping their savings to supplement their everyday spending needs. While this strategy of borrowing from Peter to pay Paul may seem odd, it reduces taxable income and boosts retirement savings while maintaining your standard of living.

Take control

One bright spot of the financial meltdown is that many workers are asking for guidance about how to do a better job of saving for retirement. Plan sponsors are stepping up to the plate by offering one-on-one advice on how much workers need to save and how to invest those savings.

But what if you're not satisfied with the investment choices in your 401(k) plan? You can invest any way you like through a traditional or Roth IRA -- but you should still contribute enough to your 401(k) to capture the employer match. Depending on your plan's rules, you may be able to transfer your accumulated balance to an IRA while you're still working once you turn 59½ years old. (Check your employer's Summary Plan Document to see whether you have this option, known as an "in-service distribution.")

That's what Carol Gabica of Melbourne, Fla., did as soon as she could. Gabica, now 61, started working with Dan Deighan, of Deighan Financial Advisors, about two years ago. She followed his advice to double her 401(k) contributions from 6% to 12% of her salary. Then in the spring of 2008 -- before the market meltdown -- she transferred her entire balance to an IRA and turned it over to Deighan to invest.

Gabica, a business-development manager who expects to work another five years or more, directs her new contributions to a stable-value fund inside her 401(k). Each time she builds up enough cash, she transfers it to her IRA. "When it comes to my retirement plan, I have a lifestyle picture in mind," says Gabica. "Dan is very cognizant of that, and he's helping me to achieve it."

Mary Beth Franklin
Former Senior Editor, Kiplinger's Personal Finance