Retirement can easily cost $1 million or more, and some people might need to save $2 million to cover all their costs. It can feel like you'll never get there sometimes, even if you're dutifully putting money into your 401(k) every pay period. But there's good news.
With the right savings strategy, it's possible to retire a millionaire using only your 401(k), but that doesn't mean this is always the best approach for you.
What does it take to become a 401(k) millionaire?
It's actually not too difficult to become a millionaire with a 401(k) -- if you're able to save enough. You can contribute up to $19,500 to a 401(k) in 2021, or $26,000 if you're 50 or older. These limits will rise to $20,500 and $27,000, respectively, in 2022. That's much higher than what you get with most other retirement accounts, including IRAs.
If you're able to contribute the current maximum of $19,500 to your 401(k) every year, it would take a little over 22 years to reach $1 million, assuming a 7% average annual rate of return. And you could be at $2 million in less than 31 years. If you increase your contributions every year to match the new annual limits, or if you get a 401(k) match from your employer, you could become a millionaire even faster.
But for most people, setting aside $20,000 per year for retirement isn't realistic. That doesn't mean you can't save a million, though. You just have to adjust your expectations. If you have 40 years until retirement, you can reach $1 million saving just $405 a month, or about $4,860 per year, again assuming a 7% average annual rate of return. That's a lot more realistic for most people.
Everyone's situation is a little different, though. And there may be times when a 401(k) isn't the best option, or you want to supplement your strategy with another retirement account.
When shouldn't you contribute to a 401(k)?
A 401(k) can be a great place to stash retirement savings, especially if you get a 401(k) match. But they have their drawbacks as well. You usually have fewer investment choices with a 401(k) than you do with an IRA, and 401(k)s can also have higher fees. This can slow the growth of your savings.
If your company only offers a single type of 401(k), you also don't get to choose whether you pay taxes on your contributions or your withdrawals. This could result in you giving more of your savings to the government than you need to.
You should definitely contribute to your 401(k) first to maximize your company match. But after that, if you don't like your plan's investment options or aren't comfortable with its fees, consider switching to an IRA. You can choose between a traditional IRA and a Roth IRA so you can pay taxes whenever it's most advantageous for you. A Roth IRA is usually the smart move unless you believe you're in a higher tax bracket now than you will be in once you retire -- then a traditional IRA might make more sense.
Another option is to stash your savings in a health savings account (HSA). These aren't retirement accounts, but they offer many of the same perks. Your contributions reduce your taxable income for the year -- and if you use the money for medical expenses, you don't pay taxes on it at all. But if you choose to use an HSA for your retirement savings, make sure you pick a provider that will allow you to invest your funds to help them grow more quickly.
The biggest problem with IRAs and HSAs is their low contribution limits. You may only contribute up to $6,000 per year to an IRA (or $7,000 if you're 50 or older). Individuals may only contribute up to $3,600 to an HSA in 2021, while families may contribute up to $7,200. These limits will rise by $50 and $100, respectively, for 2022.
If you end up bumping into these ceilings, you may want to consider switching back to a 401(k) so you can contribute even more to retirement, but again, that's your call.
You might decide that you like your 401(k) and you only want to put your savings there. That's fine too. The important thing is to weigh the pros and the cons of the different types of retirement accounts available to you and choose the ones that make the most sense for your situation.