Basically, there are two ways to make up for lost time and have adequate savings for retirement. The first is to take action that can result in a larger nest egg before retirement. The second is to take action to reduce the amount of savings required after retirement. The following eight preretirement strategies, explained in detail, are intended to result in increased retirement income.

Increase Contributions to Increase Retirement Savings
A recent study found that Americans contribute an average of 6.8% of their pay to 401(k) retirement plans — far less than the maximum annual limit for many people. Thus, a clear catch-up strategy is to kick savings up a notch by contributing more to tax-deferred 401(k), 403(b), and Section 457 plans. The best times to do this are when you receive a raise, or other increase in income, or when household expenses, such as a car loan or child-care expenses, end.

Some tax-deferred plans also include matching employer contributions. For every dollar you save, your employer might kick in another 25 cents, 50 cents, or even a dollar, up to a certain percentage of your pay (for example, 6%). If you are not saving the amount required to earn the maximum match from your employer, you are essentially throwing away “free money.”

Table 4 shows the amount late savers can accumulate by age 65 by saving 2% of earnings annually or by a 1% contribution from you and a 1% match from your employer. The analysis assumes that savings earn a 7% average annual return and that a worker’s initial contribution is based on his or her current salary (for example, 2% of $30,000 is $600) and remains constant over time. If earnings and hence, retirement plan contributions, increase, the amount accumulated will be even higher. Taxes and inflation are ignored for simplicity.

Table 4
Savings at Age 65 from an Additional 2% Contribution to Tax-Deferred Savings

• Use retirement savings calculators to perform calculations with different amounts of hypothetical savings. Visit the Money magazine Web site at http://money.cnn.com/pf.
• Consult with your workplace human resources office to determine how much money you are eligible to contribute to a tax-deferred savings plan, how much employer match is available, and the historical performance of different plan investment options. Attend workplace investment seminars, if offered, to increase your knowledge.

Accelerate Debt Repayment and Spend Less
Saving for retirement and reducing debt are closely related. The sooner outstanding debt is repaid, the sooner monthly payments can be reallocated to retirement investments. In other words, compound interest will begin to work for you, rather than against you. Adding even small amounts to the minimum payment due on a credit card can produce dramatic results. Interest costs are reduced and the time required to repay a debt is shortened considerably.

According to the book Slash Your Debt, by Detweiler, Eisenson, & Castleman, saving and then adding your daily pocket change to minimum debt payments can make a big difference in borrowing costs as shown in Table 6. The analysis assumes three different outstanding balances, a 17% credit card interest rate, and a minimum payment of 2% of the outstanding balance.

Table 6
Saving Interest Payments and Time
By making credit card payments beyond the required minimum, you can save the following amounts in interest and reduce the years in the repayment period.

Source: Slash Your Debt by Detweiler. Eisenson, & Castleman (1999, Financial Literacy Center)

If you have a balance of $5,000 on a 17% credit card and pay only the minimum required each month, it could take 40 years to pay and your total interest charge would be $16,304. By applying just 10 cents a day more to paying off your balance, you could save $2,257 in interest costs and pay off your balance 11 years sooner. Plus, once you’ve paid off the debt, you can start investing that same amount of money — and start earning interest instead of paying it.

Additional ways to accelerate debt repayment and reduce the cost of borrowing include:

• Contact creditors and request a lower interest rate. Sometimes, they will comply because it costs them more than $100 in marketing costs to replace you as a customer.
• Transfer outstanding balances to a lower-rate credit card and continue paying the amount that you paid before. Do be aware of balance transfer fees (such as 3% of the transferred amount).
• Transfer a high-interest credit card balance to a lower-rate secured or unsecured personal loan and pay it off in three to five years.
• Refrain from incurring new debt if your ratio of monthly consumer debt payments to net income is 15% or higher (example: $350 of consumer debt ÷ $2,000 net pay = 17.5%).

Use one of the many loan and budget calculators on the Internet; for example, Credit Union National Association’s Web site (http://cucalc.cuna.org/calc_index_.html?sub_id=0) to make estimates of the amount of money you can save by paying off debt quickly and reducing expenses.
Read the book Slash Your Debt by Gerri Detweiler et al. to gain an appreciation of the amount of money you can save with various debt reduction strategies.

Moonlighting
If you decide to moonlight, be sure to set aside most — if not all — of the additional income for retirement. A second job, consulting, or self-employment through a home-based business in addition to your “day job” provides several benefits for catch-up savers:

• Increased household income and additional funds for retirement savings.
• Development of new career skills and a possible “bridge job” to work at following retirement.
• Access to tax-deferred SEP and Keogh plans designed for self-employed persons.
• Reduced taxable income with deductions for business-related expenses (for example, professional dues and travel) that might be limited as an employee.

This strategy is not for everyone, however. A major disadvantage of moonlighting is the time required for working additional hours. Plus, you’ll need to know a trade or have job skills (such as computer skills) that can transfer to another work experience. Also be prepared for any associated costs such as travel and equipment purchases.

Nevertheless, moonlighting can result in significant additional savings for retirement. Table 7 indicates the amount you can accumulate over a two-, 10-, 16-, and 20-year period with an annual deposit of $5,000 of annual income derived from moonlighting.

Table 7
Retirement Savings Possible from Saving $5,000 of Income Annually from Moonlighting

Worksheet 3: Supplemental Income Planning Worksheet

Resources

• Consult your local chapter of SCORE (Service Corps of Retired Executives) for free business counseling. Other helpful resources for new business owners include the U.S. Small Business Administration, business departments of community colleges, and local Chambers of Commerce.
• Use a financial calculator or the “What Will My Savings Be Worth?” calculator on the Reader’s Digest Web site (www.rd.com/tools/alltoollist.jhtml#Money) to determine how much money you could save from earnings by moonlighting.
  

Invest Assertively
Historical investment data consistently uphold the following two principles:

• The more stock investors own, the higher their average annual return over time and the greater their portfolios’ volatility (ups and downs of share prices). U.S. stocks have earned more than 10% since 1926 compared to about 5% for Treasury bonds and less than 4% for Treasury bills, according to Ibbotson Associates, the Chicago investment research firm. Past investment performance is no guarantee of future earnings, however.
• Investment volatility is reduced over long time periods (10 or more years), a principle known as time diversification.

Another catch-up strategy, albeit with increased investment risk, is to place more stock in your portfolio before and/or after retirement. Remember, your investment time horizon is your entire life expectancy, not your retirement date. If you are 45, for example, you may have another 15 to 20 years before you retire and another 20 to 25 years of life expectancy afterwards. That’s plenty of time for compound interest to work its magic and to ride out painful market downturns such as those experienced during the 1970s and early 2000s.

As noted previously, the Rule of 72 estimates how long it takes a sum of money to double at different interest rates. To illustrate how decisions about what to invest in—a process known as asset allocation—affect the growth of an investment, consider the following example based on the Rule of 72.

Two 50-year-old workers change jobs and decide to invest their $20,000 lump sum distributions from a 401(k) plan into rollover IRAs. Worker A invests the money very conservatively in bonds, money market funds, and Certificates of Deposit (CDs) that earn a 4.5% average annual return. Worker B invests in a total stock market index fund that tracks a broad U.S. stock market index. The mutual fund earns a 9% average annual return, which is twice the return earned by Worker A. Ignoring taxes for simplicity, their rollover IRAs would grow as follows through retirement. Note that Worker B, with a higher average return, has four times as much money as Worker A because his or her savings doubles twice as often as Worker A, or four times instead of two.

Table 8
Comparison of Investment Growth at Two Interest Rates

To calculate your risk tolerance, visit the Purdue University “Planning for a Secure Retirement” Web site at http://www.ces.purdue.edu/retirement/Module1/module1.html or visit www.kiplinger.com/tools/riskfind.html.
Visit the Web sites www.ibbotson.com and www.morningstar.com to obtain information about the historical performance of different investments.
For mutual funds, review the prospectus, which indicates the fund’s average annual total return over the past one, five, and 10 years. Past performance is no guarantee of future earnings, however.

Maximize Tax Breaks and Reduce Investment Expenses
Compound interest works best when you can eliminate, reduce, or defer income taxes and keep investment expenses to a minimum. High income taxes and high expenses reduce investment performance. Table 9 shows the growth of a $10,000 lump sum investment under three different scenarios: no taxable gain on investment earnings (for example, tax-free investments such as municipal bonds and Roth IRAs), deferred capital gains taxes paid at the 20% long-term capital gains (LTCG) rate, and taxes paid each year at a combined 31% federal/state tax rate. The calculation assumes a 10% average annual return. Note that the gap in asset growth among the three investment scenarios widens substantially over time.

Table 9
Growth of $10,000 Savings at 10% in Three Income Tax Scenarios

• Visit the U.S. Securities and Exchange Commission’s Web site at www.sec.gov and click on “Interactive Tools.” The Mutual Fund Cost Calculator (to compare mutual fund costs) and the Tax-Free vs. Taxable Yield Calculator will be of particular interest to late savers.
• The Retirement Catch-Up Guide by Ellen Hoffman (2000, Newmarket Press). Chapter 6 provides information about tax-deferred retirement savings plans.