According to the Bureau of Labor Statistics, 60% of Americans have access to a 401(k), and only 42% of them are using it. But this popular savings account could be one of the best ways that you can accumulate a significant amount of money for retirement.
While most Americans aren't maximizing the benefits that these accounts provide or using them at all, they are a huge resource. Here are three ways they could help you become a millionaire.
1. Dollar-cost averaging lets you save smaller amounts over time
When you dollar-cost average, you invest a pre-set sum of money on a regular basis into a chosen investment or investments. This strategy helps you avoid having uninvested money just sitting in cash and earning nothing, and it can grow your accounts more over the long term. It also prevents you from timing the stock market because the process is automated. Rather than guessing at the best time to buy a security, you purchase it at a variety of different prices over the course of your investment time horizon.
Your 401(k) already employs this method by taking the same amount from your paycheck each pay period. And when these contributions hit your account, they get allocated across your holdings. Dollar-cost averaging can help you reach your retirement savings goals by allowing you save small amounts of money over time instead of coming up with large lump sums of money that may be unattainable. And when invested, those small amounts can add up big.
If you could save $10,000 over the course of a year and earn 7% on average each year, your 401(k) balance could grow to more than $1.01 million in 30 years. Earning a higher rate of return requires that you take on more risk, and it may not be suitable for you. But if you have time on your side and can withstand higher volatility, it could lower the amount of money that you need to save every year. And if you can earn 8.2% every year on average, you could grow your account to that same $1 million figure in 30 years by saving only $8,000 in combined annual contributions.
2. An employer match could help you increase your contributions
If your 401(k) includes an employer match, you could meet your goal of becoming a millionaire with fewer of your own dollars. In this case, your employer will contribute a percentage of your income for every dollar that you add, up to a max.
For example, if you make $70,000 a year and your employer has a 3% match, they will add $2,100 each year to your 401(k). If you contributed 5% of your salary, you would be adding $3,500 to your 401(k) each year and your employer match would make that $5,600. If you did this every year for 30 years and earned 10% on average on your investments, you could grow your account to more than $1 million.
Even if you can't contribute that much, adding enough to your 401(k) every year so that you qualify for the match could still help you stack up your savings. If you could only contribute the $2,100 needed for the match for a total annual contribution of $4,200, your account could still grow to $760,000 in 30 years if it earned the same rate of return. That's why you should aim for contributing at least enough every year so that you can get the highest possible company match available.
3. Tax deferral could allow you to make bigger contributions because of tax savings
The money that you put into your 401(k) comes out of your paycheck before you pay taxes. And while you will eventually owe Uncle Sam for this income, it won't be until you take it in the form of a distribution from your retirement account. This tax savings lets you direct more money into your 401(k) every year without seeing an equivalent deduction in your paycheck.
If you make $100,000 and you are contributing 5% to your 401(k), you will be adding $5,000 each year, and based on some assumptions about typical tax rates, your take-home pay after withholding for federal, state, and employment taxes as well as the 401(k) contribution would be $59,559. If you increase that to 6% of $6,000, your annual contribution would go up by $1,000 but your take-home pay would only decrease by $630 to $58,929.
The $370 dollar difference reflects money that you saved for retirement rather than paying in taxes. Over time, these savings will help your account grow from the contributions, but also from growth on your investments and compound interest.
The benefits that your 401(k) provide may make it one of the best tools at your disposal for becoming a millionaire. And while making the maximum contribution each year to this account may not be possible, learning how you can best use this asset could help you have the retirement of your dreams.