Today, 401k plans are one of the most popular employee benefits. Companies use 401k plans to attract top talent. 401k plan is a powerful vehicle to save for retirement and become financially independent. According to Fidelity, there are 180,000 Fidelity 401(k) plans with a balance of $1 million or more. Congratulations to you If you are one of them. There are still many helpful tips that can get you to reach your financial goals while keeping your investments safe.
You hear stories about people with a million dollars in their 401k plan. Then you look at your 401k balance, and it doesn’t look as high as you would like it to be.
The path to becoming a 401k millionaire
I hope this article will guide you on your path to become a 401k millionaire.
There are many variables that can impact your 401k account – age, salary, debt, tax rate, risk tolerance, plan fees, employee match.
Becoming a 401k millionaire is not as hard as it might seem. However, you need to follow a few simple rules that can get you on the right path.
“The best time to plant a tree was 20 years ago. The second-best time is now.”
Saving early in your 401k will guarantee you the highest chance to become a 401k millionaire at the lowest cost.
I did the math for how much you need to contribute if you start fresh at any age. These numbers are based on assumptions for continuous monthly 401k contributions until reaching 65 with 7% average annual market return for a 60/40 portfolio and 2% annual inflation. Keep in mind that these assumptions are just assumptions and only for illustration purposes. Your situation could be unique and could change the math dramatically.
401k Contributions by Age if you start fresh
What drives the growth of your 401k is the power of compounding. It’s the snowball effect of accumulating earning generating more earnings over time. The longer you wait, the larger amount you will need to contribute to reaching your 1-million goal.
If you are 25-years old and just starting your career, you need to save approximately $390 per month or $4,644 annually to reach the $1-million goal by the age of 65. Your lifetime contribution between the age of 25 and 65 will be $190,000.
When you start saving in your 30s this target number goes to $560 per month. Your lifetime contribution between the age of 30 and 65 will be $241,920.
Your saving rate goes up to 1,220 per month if you start saving actively in your 40s and increases to $5,330 at the age off 55.
Take advantage of your employer match
If my recommended monthly contribution looks like an uphill battle, don’t forget about your employer match. Many employers offer a 401k match to attract and keep top talent. The match could be a percentage of your salary, one-to-one match or an absolute dollar amount. If your employer offers a 4% match, at a minimum you should contribute 4% to your 401k plan. Take full advantage of this opportunity to get free money.
In 2019, you can make up to $19,000 contribution to your 401k plan. If you can afford it, always try to max out your contributions.
Catch-up contributions when 50 and older
If you are 50 years or older, you can make an additional $6,000 contribution to your plan. Combined with the $19,000 limit, that is a maximum of $25,000 in 2019.
Obviously, owning $1 million is a big accomplishment. However, it may not be enough to sustain your lifestyle during retirement. As a financial advisor, I recommend to my clients replacing at least 80% of their income before retirement. If you are a high earner or plan to retire early, you need to save more aggressively to reach your goals.
An important part of the formula of becoming 401k millionaire is consistency. Saving every month and every year is a critical part of achieving your financial goals. On the contrary, large gaps could hurt your chances of reaching your financial goals.
Don’t panic during market turbulence
The market can be volatile. Don’t let your emotions get the worst of you. Nobody has made any money panicking. During the financial crisis of 2008-2009, many people stopped contributing to their 401k plans or moved their investments into cash. These folks never participated in the market recovery and the longest bull market in history. Stay invested. And think of this way. If the market goes down, your plan will invest your automatic monthly contributions at the lower prices. You are already getting a deal.
Watch your fees
Higher fees can erode your returns and slow down the pursuit of your financial goals. I recently advised a 401k plan, where the average fund’s fees were 1.5%. In the age of ETFs and index investing it is mind-blowing that some 401k plan still charges exuberantly high fees. If your 401k plan charges high fees, talk to your manager or HR representative and demand lower fee options.
Be mindful of your taxes
Taxes play a big role in 401k planning. Most 401k contributions are tax-deferred. Meaning that your contributions will reduce your current taxable income. Your investments will grow tax-free until you reach retirement age. You start paying taxes on your withdrawals. There are a couple of strategies you can implement to make your withdrawals to make more tax-efficient. You can reach out to me if you have any questions on that topic as every situation is unique and could require a unique solution.
Currently, some employers offer a Roth 401k contribution as an additional option to their plan. Unlike the tax-deferred option, Roth 401k contributions are made on an after-tax basis. Roth 401k contributions don’t have an immediate financial impact. However, if planned well, Roth contributions could help you immensely to reach your financial goals. For example, let’s assume that you are in a low tax bracket and your employers offer both tax-deferred and Roth 401k contributions. The tax-deferred option is usually the default. But if you are in a low tax bracket, your tax benefit will be minimal. In that case, maybe it’s worth selecting the Roth 401k.
Don’t take a loan
Under no circumstances, you should take a loan from your 401k plan. No matter how dire the situation is, try to find an alternative. Taking a loan from your 401k can set you back many years in achieving your financial goal of becoming 401k millionaire. Obviously, all rules have exceptions, but before you take a loan from your 401k, talk to your financial advisor first for alternatives.
Keep a long-term view
Life happens. Markets go up and down. You can lose your job or change employers. You need to pay off a big loan. Your car breaks down. You need money for a down payment on your first house. Something always happens. Circumstances change. Whatever happens, keep a long-term view. Your 401k plan could be the answer to your financial independence. Don’t make rash decisions.
If you need help growing your 401k savings, or learn how to manage your 401k investments, reach out to me at firstname.lastname@example.org or +925-448-9880.
You can also visit my Insights page, where you can find helpful articles and resources on how to make better financial and investment decisions.
About the author:
Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families and successful business owners.