Retirement accounts are accounts designed to not only help you save for retirement, but invest for it as well. Of course, you could technically invest for retirement using a standard brokerage account, but retirement accounts come with special IRS tax treatments that make them ideal for the long term.
The most popular of these retirement accounts is the 401(k). When used properly, a 401(k) will be one of the best resources to accomplish your retirement goals. Here's how many years of maxing out your 401(k) it'll take to become a millionaire.
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How a 401(k) works
401(k) accounts are employer-sponsored retirement accounts that allow you to contribute pre-tax money into the account. Since you're contributing pre-tax money, your taxable income will be lower, likely resulting in a smaller tax bill or higher tax return. For tax year 2022, the most you can contribute to a 401(k) plan is $20,500 ($27,000 if you're 50 or older). So, if you make $100,000 annually and max out your 401(k), only $79,500 of your income will be taxable ($73,000 if you're 50 or older).
One of the best features of a 401(k) plan is that many employers will match your contributions to your plan. Exactly how much they'll match varies by employer, but regardless, if it doesn't put your livelihood at risk, you should always aim to contribute as much to your 401(k) as your employer will match -- it's essentially "free" money. If they match 3%, 3% should be your minimum contribution; if they match 5%, 5% should be your minimum contribution; and so forth.
Compound returns will do most of the work for you
If the 401(k) contribution limit were to stay at $20,500, it would take over 48 years of contributions to get you to $1 million. Considering the U.S. retirement age is 67, this is unlikely to happen. Instead, you should let compound returns do the work for you.
If you were to invest your 401(k) contributions into a fund that returned 10% annually -- the historical return for the S&P 500 -- with a 2% fee (which is on the higher end), here's how many years it'd take you to become a millionaire with compounding:
| Yearly Contributions | Annual Return | Plan Fees | Years Until $1 Million |
|---|---|---|---|
| $20,500 | 10% | 2% | 21 |
| $41,000 (includes employer match) | 10% | 2% | 15 |
| $27,000 | 10% | 2% | 18 |
| $54,000 (includes employer match) | 10% | 2% | 12 |
Data source: Author calculations.
For the sake of comparison, here's how much you'd have if you only saved your 401(k) contributions for those years instead of investing them and letting compounding work its magic:
| Yearly Contributions | Years | Amount Saved |
|---|---|---|
| $20,500 | 21 | $430,500 |
| $41,000 (includes employer match) | 15 | $615,000 |
| $27,000 | 18 | $486,000 |
| $54,000 (includes employer match) | 12 | $648,000 |
Data source: Author calculations.
While these are no small amounts by any means, they're still a ways away from the amount you'd have saved with investing and compound returns.
Strictly saving likely won't get the job done
There is nothing wrong with saving by any means, but strictly saving money will likely not get you to your savings goals when it comes to retirement. Instead, you want to put your money to work for you by investing. In the two scenarios above, nothing changed on the contributor's end; they contributed the same amount of money in each case. But just by investing instead of solely saving, there was a difference of hundreds of thousands of dollars in the end.
That could mean a world of difference when you're retired and relying on that income, so be sure to take it seriously -- you won't regret it.
