Who says nothing good can come of the nation's byzantine tax code?

Twenty-five years ago, a young employee benefits consultant in Philadelphia was studying the Internal Revenue Code when he came across a passage that got him thinking.

What Ted Benna noticed was new language in the code that he thought permitted the creation of a new type of retirement plan. Not only could employees save money tax deferred, Benna felt, but the new language also allowed workers to fund such retirement accounts by setting aside a portion of their salary before taxes. The Internal Revenue Service later agreed.

His idea, of course, turned out to be the 401(k), the first of which was established at Benna's own firm on Jan. 1, 1981.

A quarter century later, these employer-sponsored retirement accounts have become as ubiquitous in the workplace as E-mail and corporate downsizing.

Yet it may take another 25 years before 401(k)'s can be deemed a success or a failure. This may sound silly, since around 43 million workers have already stuffed more than $2 trillion into these accounts.

But older baby boomers, the first generation to have climbed the corporate ladder in the 401(k) era, are just now turning 60. This means that boomers have only begun the long and anxious transition from work life to retirement. And since many boomers are expected to live well into their 80s, it's too early to say whether 401(k)'s have encouraged a sufficient level of saving to fund a full--and fulfilling--retirement.

Coming up short. So far, the news is decidedly mixed. While the vast majority of workers eligible for 401(k)'s contribute to these tax-deferred plans, a third of workers 60 and older aren't using them. Even among older boomers who are participating, nearly 20 percent don't take full advantage of their company matches.

The upshot: The average 50-something has less than $130,000 saved up in his or her account. Workers 60 and older aren't doing much better: They have only slightly more than $136,000 in their 401(k)'s, on average. That's barely enough to generate $6,000 to $7,000 a year of income during retirement, assuming they withdraw no more than 5 percent of their account each year. What's more, these are just averages, which can be skewed by wealthier workers with large balances. The median 401(k) balance for those 65 and over is only about $53,400, according to the Vanguard Group. "It's pretty scary," says Mark Kenison, president of Kenison Financial Services, a planning firm near Charlotte, N.C. "If it were me, and I only had $50,000 in my 401(k), I'd be terrified."

Older boomers are. A recent retirement confidence survey found that only 1 in 5 older workers is "very confident" of having enough money to finance a comfortable retirement. Even fewer are confident of being able to save enough to cover medical expenses and long-term care during retirement.

Compounding these worries is the confusion surrounding the ever changing landscape of tax-advantaged savings. This year, Uncle Sam is beginning to allow companies to establish a new type of 401(k) known as the Roth 401(k) (story, Page 42). These newfangled accounts differ from traditional 401(k)'s in that you contribute to them with after-tax dollars. Traditional 401(k)'s are primarily funded with pretax money. But in exchange, workers are allowed to pull money out of Roth 401(k)'s tax free at retirement. Money withdrawn from a traditional 401(k) is generally taxed as ordinary income.

Cashing in on 401(k)s

At the same time, President Bush's tax simplification committee has proposed overhauling the alphabet soup of tax-deferred retirement accounts by creating uberaccounts that could eventually replace 401(k)'s and IRA s as we know them. If this proposal--which has yet to be embraced by the White House--ever comes to pass, it will only add to the confusion.

Easy does it. Regardless of what the government does, the 401(k)--or some iteration of it--is likely to be a worker's best friend over the next quarter of a century. Jeff Carney, president of Fidelity's personal investments division, notes that "maxing out on your 401(k), especially if there's a company match, is the easiest way to save."

Benna agrees. The father of the 401(k), who recently founded a benefits firm that helps small companies offer retirement plans, says workers should be saving more in their 401(k)'s. "Do we have better alternatives than the 401(k)?" he asks. "The answer is still no."

So what can older workers do to repair or jump-start their 401(k)'s? For starters, it's important to keep things in perspective. While planners are right to fret over the state of older boomers' retirement savings--after all, that's their job--boomers need to be mindful of a few facts:

There's more to retirement savings than just the 401(k). Some older boomers, for example, are still fortunate to have guaranteed pensions from their employers.

Social Security, while less secure than it used to be, is still likely to cover about 40 percent of a typical middle-class retiree's annual income--and more for working-class households.

Don't discount the biggest financial asset that you probably own--your home. Retirees who have paid off their mortgages can count on having additional income at their disposal. Home equity also could provide another source of income, as could reverse mortgages.

All told, some boomers might find themselves with 50 percent or more of their retirement income needs taken care of.

Now, let's turn to the 401(k).

Calculate how much you'll need to retire, starting by determining how much annual income you'll require to fund a comfortable retirement.

Once you do that, you can work backward. Say you figure you'll need $50,000 a year to live comfortably in retirement. And you assume that a combination of Social Security, pension income (if you have it), and home equity will pay for half of this. This means your 401(k) needs to cover the remaining $25,000 or so.

How big would your 401(k) have to be to safely generate $25,000? Rande Spiegelman, vice president of financial planning at the Schwab Center for Investment Research, says a simple formula is the "Rule of 25." Figure how much you'll need to withdraw from your savings in the first year of retirement--and then multiply that by 25. So, in this example, 25 times $25,000 equals $625,000.

Concentrate on boosting your savings rate. Let's face it: Most workers don't have anything close to $625,000 in their 401(k)'s. So what are the options?

Other than delaying retirement, you really only have one safe choice--and that's to save as much as you can in your remaining working years, says Mike Scarborough, president of the Scarborough Group, an investment advisory firm. "If you're going to be aggressive at this stage in your life, be aggressive in saving, not in how you invest," he says.

Cashing in on 401(k)s

Daniel Sabedra is following this advice. Like most 401(k) investors, Sabedra, 59, wasn't able to save through a 401(k) throughout the past quarter century. The Davison, Mich., resident, who serves as a general manager at a truck equipment distributorship, notes that his firm only started its 401(k) in 1992. Moreover, like most investors, Sabedra was dinged by the recent bear market--his account lost around a quarter of its value.

To make up for lost ground, Sabedra didn't change his investment strategy. Instead, he says, "I'm just trying to save as much as I dearly can." Because of his employer's plan rules, Sabedra has been allowed to stuff away only around 7 to 10 percent of his salary each year. But recently, he has supplemented his 401(k) with savings in IRA s and outside accounts to the point where he is close to setting aside 23 percent of his annual salary.

This is a smart move. T. Rowe Price recently crunched the numbers and found that saving 15 percent a year--or even better, 25 percent annually--is what's needed to meet one's retirement goals. That is considerably more than the average person saves.

Utilize catch-up savings options to boost your savings rate. Stephen Utkus, who heads up the Vanguard Center for Retirement Research, notes that "if you're in your 40s and 50s and have already saved three or four times your income, you're not going to have much difficulty" meeting your retirement goals. But if you're in your 50s and you've amassed only one or two times your salary, you've got some work ahead, he says.

Fortunately, Uncle Sam allows workers 50 and older to make up for lost time through so-called catch-up provisions for both IRA s and 401(k)'s. In 2006, older boomers are allowed to stuff an additional $5,000 into their 401(k)'s, over and above the federal 401(k) annual cap of $15,000. Even workers who feel they're on track to meet retirement goals would be wise to take advantage of these catch-ups.

Take Steve Rowlan, an environmental engineer who lives in Charlotte, N.C. Rowlan turns 50 this year. While he's confident that his 401(k) is large enough to meet his retirement needs, Rowlan still plans to take advantage of the catch-ups. Why? The way he figures it, he's earning more than he ever has in his career. Therefore, it makes sense "to defer as much as I possibly can to keep the tax man away," he says.

Don't take unnecessary risks in your 401(k). Karen McIntyre, a financial planner in Spring House, Pa., says a big mistake some older boomers make is swinging for the fences at the end of their careers in hopes of making up for lost time. But if you load up on risky stocks, "you may end up doing more damage than good," she says.

Think about it: If you're 60 and have only $136,000 saved up, it would take annual gains of 36 percent to turn that $136,000 into $625,000 in just five years. Good luck trying to find that magic bullet. And good luck avoiding major losses.

Cashing in on 401(k)s

The need to sidestep major investing land mines late in your career is one reason financial experts say older boomers need to cut back on their allocation to company stock. Hewitt Associates recently found that workers 60 and older hold more of their 401(k) balances in company stock than do those of any other age group, with an average allocation of nearly 28 percent.

Look to improve your investment returns modestly --by 1 or 2 percentage points a year. To reiterate, it's risky to try to make up for lost ground by swinging for the fences. But improving your returns by even a percentage point each year can still help. Remember, if you're 55 and plan to retire at 65, you might not have to touch the bulk of your 401(k) until you're 70 or older. That gives you 15 years or more to invest.

A simple way to find an additional percentage point in gains each year is not to chase the hottest funds (because they have a tendency to cool off once they're noticed). Instead, see if you can find solid investment options that charge low fees, such as low-cost index funds.

Investors often don't realize it, but every percentage point their mutual fund charges in annual expenses comes straight out of their total returns. In other words, a fund that generates 8 percent in market gains but charges 2 percent in annual expenses will deliver real returns of only 6 percent.

Put things on autopilot. Many 401(k)'s now offer so-called target retirement, or life-cycle, funds. These are one-fund solutions that not only invest in a mix of stocks and bonds but automatically rebalance your holdings each year. What's more, as you age, these funds gradually shift you into a less aggressive investment mix.

While target retirement funds aren't likely to be the absolute best-performing choices, they often help investors who neglect their 401(k)'s. Hewitt recently studied 401(k) participant performance in 2003 and 2004. It found that workers who used these target retirement funds earned about 1 to 2 percentage points more in their 401(k)'s during that time than those participants who put together their own mix of stock and bond funds.

Keep money in your 401(k) for as long as you possibly can. If saving more and investing better don't do the job, your other option is to work a bit longer. "Even working two years longer can have a big impact," says Lori Lucas, director of retirement plan participant research at Hewitt.

That's because working longer accomplishes three things: First, it lets you collect a few more years of income, which you can sock away. Second, you don't have to tap that part of your 401(k) that would otherwise have been needed to cover basic living expenses. And finally, it shortens the length of your retirement.

Hewitt recently studied the retirement savings of workers at the nation's biggest corporations--firms that traditionally offer the best benefits packages. It found that workers 55 to 59 who planned to retire at 65 could expect to replace nearly 80 percent of their preretirement income through a mix of 401(k)'s, pensions, and personal savings. But if those same older boomers worked until 67, they'd be likely to replace nearly 93 percent of their salaries.

Cashing in on 401(k)s

Instead of working full time longer, some, like Sabedra, are thinking of working part time during retirement. The good news is, you don't have to strive to make big money. Even $10,000 or $15,000 a year in part-time income can help, says Warren McIntyre, a financial planner in Troy, Mich.

Here's why: Academic research has shown that investors can really afford to withdraw only 4 to 5 percent of their retirement savings--based on historic market returns--without risking depleting their accounts prematurely. So, say you need to withdraw $25,000 a year from your 401(k). But assume you have only $300,000 saved up in your retirement accounts. That would amount to an 8.3 percent withdrawal rate. Now, if you could earn just $10,000 a year working part time, you might need to withdraw only $15,000 from your 401(k). That works out to a much safer 5 percent withdrawal rate--one that might make your money last as long as you do.

For his part, Sabedra says he has already talked to his employers about "retiring" early at age 62 but working three days a week thereafter. "I don't plan on totally retiring," he says. "I'll always continue to work."

That could turn out to be the mantra for older boomers. For some, it will be because they want to work--but for others, because they have to.

GROWING THE NEST EGG

Account balances continue to grow as workers age, but 401(k) participation peaks with 50-somethings.

AVERAGE 401(k) ACCOUNT BALANCES IN 2004

Age

20s $31,844 46.1 pct.

30s $63,710 66.4 pct.

40s $100,106 71.7 pct.

50s $129,218 72.3 pct.

60s $136,400 64 pct.

401(k) PARTICIPATION*

*Percent of eligible workers at each age who make contributions.

[labels]

$120(in thousands)

80

40

0

Sources: Investment Company Institute,

Employee Benefit Research Institute, Hewitt Associates