Becoming a millionaire might seem out of reach. But you can significantly grow your retirement savings over time, and it's not as difficult as it may seem.
Most people intend to save for retirement but don't know the best tools to accomplish their financial goals. An employer-sponsored retirement plan like a 401(k) can be a secret weapon most working people can access.
I'll show you how you could leverage their 401(k) to retire a millionaire.
Four in 10 employees make this 401(k) mistake
A survey found that 4 in 10 people with access to a 401(k) plan don't use it. Frankly, this is personal finance malpractice! Decades ago, employees worked for companies and received pensions when the time came to hang their hats for the last time.
However, employers have steadily shifted the responsibility of retirement planning to employees. Pensions are rare these days, replaced by the 401(k) plan. It's a tax-deferred investment account, which means you put pre-tax dollars in, reducing your taxable income for that year. The catch is that you pay taxes on your withdrawals in retirement.
Many 401(k) plans offer an employer match to incentivize employees to use their plans. Some may match $0.50 on the dollar up to a certain percentage of salary or even a dollar-for-dollar match. Either way, you must participate in the plan and contribute the required amount to earn it.
This is free money! A 100% match means your out-of-pocket contribution has already doubled before it's even invested.
Compounding your nest egg with a 401(k) plan
The 401(k) can pack a punch; the math will highlight that. Yes, you can still retire very comfortably, even if you're getting a late start. For example, suppose Jennifer has worked hard and been hired to a position with a $70,000 salary. She's 35 but hasn't set aside any savings.
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She enrolls in her company's 401(k), which matches dollar-for-dollar up to 2% of her salary. She ultimately decides to set her contribution at 5%. That means 7% of her salary is invested annually, $3,500 of her own money plus $1,400 of matching for a total of $4,900. Jennifer allocates her contributions to index funds that track the S&P 500. It's the leading benchmark for the broader stock market and has returned an average of 9.4% annually over the past 50 years.
Starting her 401(k) plan from zero on day one, it would grow to $1.15 million by age 67. The best part is that 401(k) contributions are typically taken directly from your paycheck, so your investing is out of sight and mind but working for you the whole time.
When all is said and done, Jennifer contributed $112,000 of her own money during that time, but a combination of compounding and additional employer funds increased her savings tenfold.
Things to keep in mind
Even great tools require careful use; the same goes for your 401(k) plan. These are retirement plans designed specifically to grow money you should only need much later. After all, there are potential penalties for touching your 401(k) before retirement age, and you'll lose wealth if you disrupt the compounding process.
Don't contribute money you know you might need sooner. A 401(k) is not a savings account or an emergency fund. Additionally, the stock market can be volatile. Be prepared to see your 401(k) balance fluctuate over time. Remember, it's an average of 9.4% over time, which could mean a 20% fall in one year and a surge of 30% the next.
But if you understand this, contribute responsibly, and keep your hands out of the cookie jar, you can multiply your retirement savings and dramatically improve your financial outlook.
