By Albert B. Crenshaw
Sunday, December 18, 2005

There was a lot of cheering around Washington last week as the House pushed through its version of a bill to toughen up funding requirements on companies that operate traditional pension plans. But to workers, especially younger ones, the noise should sound less like an ovation than an alarm clock.

The measure -- assuming it becomes law; it still must be reconciled with a Senate bill on the same subject -- is often described as a mechanism for making employers "keep their promises" made to workers via pension plans.

But while it may accomplish that, and there is little debate that such protection is desirable, the measure provides no assurance that employers will actually continue to make the promises lawmakers want them to keep.

In fact, traditional pensions continue to be frozen or terminated at an alarming clip. Some 1,000 of these "defined benefit" plans failed or were simply shut down by employers voluntarily this year, and in most cases, unless the company itself folded, they were replaced by a new or sweetened 401(k)-type plan. So as we approach the beginning of a new year, American workers, even those who now have a traditional pension, should begin to review their savings and retirement plans. This applies doubly to young workers, who are less likely than ever to have a traditional pension but who do have time to make a 401(k) plan "work" in the sense of piling up enough money to get through retirement.

The Bush administration and the Republican-led Congress -- which believe in what they would call self-reliance and others might call do-it-yourself retirement -- have improved the tax benefits that go along with this philosophy, and to the extent they can, workers should take advantage of those breaks.

Beginning Jan. 1, the final increase in the contribution limits for 401(k) plans clicks in. In 2006, workers will be able to contribute as much as $15,000 in pretax dollars to their k-plans, up from $14,000 this year. Those aged 50 and older can kick in another $5,000 -- for a total of $20,000 -- all pretax.

After 2006 the ceiling will be indexed for inflation in $500 increments. That means no increase until there has been $500 worth of inflation, at which point the limit is increased by that amount.

For those who contribute to an individual retirement account, the limit for workers under 50 remains $4,000 in 2006, the same as this year. However, the additional "catch-up" contribution allowed for those 50 and up rises to $1,000 from this year's $500. This means 50-year-olds can put a total of $5,000 into an IRA.

Contributing the full amount to either of these types of vehicles is going to be a stretch for many families. But workers shouldn't let that discourage them. If you can't do the full amount, do something. If your company matches some of your contributions, that's a good place to begin: Put in enough to get the full match -- typically 5 or 6 percent of pay -- and then ratchet up the amount later. Five percent of pay for a $50,000-a-year worker is $2,500. If the company matches, say, half of that, $3,750 goes into your account.

A recent study by benefits consultants Hewitt Associates found that workers who do not contribute to their k-plans can on average expect to see their income fall to just slightly more than half of what they need to maintain their pre-retirement standard of living, even if they have a pension along with Social Security.

Since the figures are averages, and include people not covered by the pension, they may understate the benefit of a traditional pension, but "it's fair to say that for employees who have a defined benefit plan, the 401(k) is still critically important," said Lori Lucas, director of participant research at Hewitt.

Workers who do contribute the average 8 percent of pay and who have a pension and Social Security can, again on average, expect to replace 98 percent of their pre-retirement income when they walk out the door, that study found.

That may sound good, but even that won't be enough for many workers when inflation and the rising cost of medical insurance and care are factored in. And for those with no pension, the picture is even grimmer.

But it's not hopeless, the study found. If workers who have only a 401(k) plan boost their contributions by 2 percentage points -- to 10 percent -- they can reach a level very close to what they need to keep their pre-retirement standard of living, it concluded.

Workers lucky enough to be maxed out on their k-plans should look at the Roth IRA next, experts say.

A Roth would be preferable to a traditional IRA because it's unlikely in these circumstances that you're eligible for a deduction, a key benefit to a traditional IRA, and withdrawals from traditional IRAs are taxed at ordinary-income rates. Indeed, experts say, with no deduction you might as well save in a taxable account where you get low rates on dividends and long-term capital gains.

But the Roth IRA goes one better. While you don't get any tax deduction for contributions, withdrawals are tax-free. The 15 percent top tax rates on capital gains and dividends are nice, but they don't beat having no tax at all.

The hitch with Roth IRAs is the income limits that bar many well-off workers from participating. Couples with adjusted gross incomes of more than $150,000 ($95,000 for a single) can't make a full contribution, and couples earning over $160,000 ($110,000 single) can't contribute at all.

But next year well-paid workers will get, assuming their employer cooperates (and many won't), a way around the Roth IRA limits. It's the Roth 401(k), which works more or less like a regular 401(k) but is funded with after-tax dollars rather than pretax. But withdrawals in retirement are tax-free.

Those worried about taxes in retirement may be interested in the Roth 401(k). As with the Roth IRA, rules during retirement are very simple -- take it out if and when you want to, tax-free, or leave it to an heir for tax-free income. On the other hand, unless Congress extends it, the Roth 401(k) ceases to be allowable after 2010, so you may get only five years of contributions. Still. . . .

This may all seem a bit complicated, and of course it is. But don't let that discourage you. At 8 percent a year, which you might get in stocks over the long run, every $100 you put in next year will be worth a bit over $1,006 after 30 years. In 40 years it would be worth $2,172. Get started.