30 Steps to a Million-Dollar 401(k)
30 Steps to a Million-Dollar 401(k)
Aiming for a million dollars is a good idea
How much money do you need to have saved for retirement? The answer is different for different people, but $1 million will serve many of us well. With $1 million, we could withdraw 4%, or $40,000 in the first year, and then adjust subsequent withdrawals for the remainder of retirement -- a strategy that the 4% rule suggests should prevent us from running out of money for 30 years.
Add Social Security income to that, and you're looking at meaningful annual income. Here are 30 steps you might take to help yourself reach that goal.
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1. Participate in your employer's 401(k)
The first step toward maximizing your 401(k) is to actually participate in one. If your employer offers a 401(k) plan, be sure you're contributing to it. A 2018 report from the Bureau of Labor Statistics National Compensation Survey noted that 81% of full-time workers had access to a retirement plan at work and that 61% of them participated in it. That's pretty good -- but it could be better. If you're among the 39% of workers not participating in your employer-sponsored retirement plan, rethink that.
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2. Alternatively, participate in a 403(b) or 457 plan
One reason you may not have access to a 401(k) at work is if you don't work for a typical private company (including many major, publicly traded businesses). You might still have access to a similar retirement plan, though. Educational and non-profit institutions offer 403(b) accounts, while state or local public jobs often feature 457 plans.
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3. Assess your 401(k) to see how good it is
All 401(k) plans are not created equal. Some are better than others. It's good to evaluate your 401(k) -- because if it's excellent, it can really be worth it to contribute as much as possible to it. And if it's a stinker, you might want to use it more modestly, putting other investment dollars elsewhere, while asking your benefits office to look into improving the plan.
Check out online resources such as BrightScope.com, where you can learn about your plan and compare it to others.
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4. Consider the Roth 401(k) instead of the traditional 401(k)
You might be familiar with traditional IRAs and their counterparts, Roth IRAs, but you might not realize that most employers now offer Roth 401(k)s as well. They work much like Roth IRAs: They accept your post-tax money, and don't give you any kind of upfront tax break, the way that traditional IRAs do. But if you follow the rules, withdrawals in retirement will be tax-free. That can be a powerful boon -- especially if you're still far from retirement and your contributions will have many years in which to grow for you.
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5. Do a little math and see how much you might amass
It can be hard to stick to your plan of saving and investing for retirement, so keep the table above in mind as motivation. It shows how you can amass a lot of money over years -- which can help you live comfortably in retirement.
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6. Be sure to have an emergency fund
Of course, before you focus on growing a big nest egg for retirement, be sure that you have an emergency fund at the ready. Many Americans are much closer to a financial crisis than they think, not appreciating that a $2,000 car repair expense could suddenly materialize, or they might unexpectedly lose their job and be out of work for a few (or many) months, or a health issue could pop up that costs many thousands of dollars. Don't be caught unprepared, and be sure to have around six to nine (or more) months worth of living expenses available.
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7. Aim to be debt-free
It's smart to be debt-free as you save for -- and enter -- retirement. Being totally debt-free is great, but many of us can't escape mortgage payments if we want to own a home. That's okay, because interest rates for mortgages are fairly low these days. It's high-interest-rate debt that's so dangerous, and ignoring it can leave you with snowballing debt. Credit card debt is particularly pernicious, often with interest rates in the high teens or 20s. It's not always easy to get out of debt, but many have done it, and so can you.
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8. Come up with some goals -- and a plan
For best results when working toward your million-dollar 401(k) account, have some goals, and an overall retirement plan. You might, for example, figure out that between you and your spouse, you can save $16,000 each year in 401(k)s for the next 20 years. If you average an annual growth rate of 8%, you'll end up with close to $800,000. If you can sock away more in later years, when, presumably, you'll be earning more, you might hit that million-dollar mark. Try to get more detailed than that in your plan, though. If you're 35 now, you might spell out that you want to have $250,000 by age 45, $600,000 by age 55, and $1 million by age 65. From there you can start outlining ways you'll get there, such as just how you'll find enough money to invest. You'll also be able to check your progress against your goals as time goes by.
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9. Save aggressively in your retirement plan
It's unlikely that you're very young right now and earning a fat salary. If you are, that's great and you should start socking away a modest portion of your earnings each year. Most of us, though, haven't saved as much as we should have at this point, so aiming for more than 10% of our income is best. For some, 15% or more may be needed.
A 401(k) plan has higher contribution limits than an IRA, so it can make it easier to save aggressively. For 2019, you're allowed to sock away $19,000 -- plus an additional $6,000 if you're 50 or older. That might be a stretch for many people, but aim to be saving and investing a lot, if you can, in your 401(k), IRA, and/or other accounts.
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10. Grab all available matching dollars
One of the great things about 401(k) plans is that many employers chip in "matching" contributions along with your own contributions. There are many possible formulas used for this, with a common match being 50% of your contributions up to 6% of your salary. For someone earning $60,000 and socking away 10%, or $6,000, each year, that would result in an extra $3,000 from your employer -- a rather meaningful sum. It's free money and a guaranteed 50% return on your investment, so try not to leave any matching dollars uncollected.
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11. Understand your plan's vesting schedule
A key thing to understand about your 401(k) plan is whether your employer contributions are subject to vesting schedules. Your own contributions will belong to you as soon as you make them, but sometimes employers don't give you full ownership of their matching contributions immediately -- because they want you to stick around. If there's a four-year vesting schedule, you might get ownership of the first 25% of a matching contribution immediately, and ownership of the next 25% the following year, and so on.
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12. Keep upping your contributions
If the most you can sock away this year is $8,000, fine. But try to make it $9,000 or more next year. And aim to increase your saving rate in the years that follow, too. Or think in percentages. If you've specified that 10% of your income should go to your 401(k), send in the paperwork next year to increase your 401(k) contribution -- perhaps to 11% or 12%. The more you save, the more you can end up with in retirement.
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13. Save and invest even if you don't have a retirement plan at work
Don't assume that you're out of luck if you don't have a retirement plan available to you at work. You can still save and invest money in a traditional or Roth IRA, and in regular, taxable brokerage accounts as well. The 2019 contribution limit for IRAs is $6,000, plus an additional $1,000 for those 50 and older. If you're self-employed, you have even more options, as there are a handful of retirement accounts for the self-employed, such as SEP-IRAs, SIMPLE IRAs, and Solo 401(k)s.
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14. Be tax-savvy
A 401(k) is a tax-advantaged retirement savings account, but that doesn't mean tax-free. Traditional 401(k)s (and IRAs) give you an upfront tax break: If you contribute $5,000, your taxable income drops by $5,000, shrinking your tax bill for the year of the contribution. The money escapes taxation until withdrawn, when it's taxed as income to you. Roth 401(k)s (and IRAs) take post-tax money, meaning that a $5,000 contribution doesn't change your taxable income or your tax bill in the year of contribution. But when withdrawn in retirement, it will likely be tax-free. Meanwhile, dividends received in a Roth IRA can escape taxation entirely, while those received in a traditional IRA end up taxed at your ordinary income tax rate, which is likely to be higher than the 15% tax rate most of us pay on dividend income in our regular brokerage accounts.
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15. Be ready for required minimum distributions (RMDs)
If you have a traditional IRA, you need to be aware of and plan for "required minimum distributions" (RMDs), and if you have a traditional or Roth 401(k), you have to do the same. An RMD is a sum you're required to withdraw from your account each year, beginning on "April 1 following the later of the calendar year in which you reach age 70 1/2 or retire," per the IRS.
Do not be late or forget to take your RMDs, because the penalty is severe: You'll have to fork over half of what you failed to withdraw.
ALSO READ: Don't Retire Until You Know These 4 Facts About RMDs
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16. Don't overdo it with your employer's stock
Yes, it's often tempting and easy to load up on shares of your employer's stock in your 401(k), but it's best not to. While you do know that company better than any or most others, there's a danger: You already have most or all of your income dependent on that one company -- so having much of your retirement dependent on it, too, is risky. It's better to diversify. Remember that even seemingly healthy companies can run into trouble and see their shares fall sharply, either temporarily or permanently. Think, for example, of Enron or General Motors or Circuit City.
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17. Don't just accept your plan's default investments
When you enroll in your employer's 401(k) plan and start contributing money to it, you should study the investment options in the menu and choose carefully. Fail to do so and you'll end up in default investments, which will likely be especially conservative. That means they're safer than many other options, but they probably won't grow very quickly, and if you're planning to grow your savings in that account over many years, that won't serve you well. Long-term money is likely to grow faster in stocks.
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18. Consider index funds for much of your money
Understand that there are two key types of mutual funds -- ones that are passively managed and ones that are actively managed. With actively managed funds, managers study the universe of investments and decide what to buy, how much to buy, and when to buy and sell. Passively managed funds -- index funds -- give their managers little to do, as each fund tracks a certain index and simply holds most or all of the same securities that the index does. Thus, they tend to charge far less in fees, which gives them a performing edge over managed funds. Indeed, per Standard & Poor's, as of the end of 2018, fully 85% of large-cap stock funds posted lower returns than the S&P 500 over the past 10 years, with nearly 92% underperforming over the past 15 years. For most investors, a low-fee broad-market index fund, such as one that tracks the S&P 500, is a good choice, recommended even by Warren Buffett.
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19. Study your options
Review the menu of investments available to you in your 401(k) plan carefully, and be smart in your investing. When looking at mutual funds, do a little research into them, perhaps at sites such Morningstar.com. With index funds, look for low fees. With managed mutual funds, read up on the funds' managers, review their holdings, see how frequently they buy and sell shares in the fund via the "turnover ratio" -- and look for low fees.
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20. Look into the fees you're charged
So how much is too much, when it comes to fees for 401(k) accounts and the funds held in them? Well, know that large employers will be more likely to offer plans with lower fees, while smaller companies will often feature higher ones. Visit BrightScope.com and you can compare your 401(k) with those at other companies. If your plan's fees seem too high, let your plan administrators know -- and consider doing much of your retirement investing elsewhere, such as in IRAs and/or regular, taxable brokerage accounts. Still -- it's probably smart to at least contribute enough to grab all available matching money.
ALSO READ: Think a 1% 401(k) Fee Is No Big Deal? Think Again.
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21. Save those raises and refunds
It's not easy to save aggressively, as most of us need most of our money for expenses such as rent, mortgage payments, food, transportation, utilities, and so on. Here are two sneaky strategies you might employ to help you save money: Whenever you get a raise, have all that extra money go to your 401(k) by hiking the amount you contribute from each paycheck. You'll end up living on the same amount you were before the raise, but you'll be sending more to your retirement savings each month. Similarly, save and invest your tax refunds too. You may not be able to do these things without fail every year, but the more often you do, the bigger a nest egg you can grow.
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22. Don't borrow from your 401(k)
If you're ever thinking of borrowing from your 401(k), think again. Yes, it can be tempting, but it's not as harmless an action as you might assume. For one thing, when you remove money from your account, it stops growing for you. You'll typically have up to five years to repay what you owe, and that's a long period in which to lose growing power. Also, many people find that they can't repay their loan in the time permitted, despite their best intentions, so they end up socked with a 10% early withdrawal penalty, plus taxation on the sum, which suddenly becomes taxable income they received. Ouch.
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23. Don't cash out your 401(k)
Don't cash out your 401(k) when you leave your job either. Even a seemingly small sum in your account can grow to a meaningful and useful size over time, if left to grow. Your options typically include leaving the money in the account (though you may face new fees if you do), rolling it over into an IRA, or moving it to the 401(k) plan of your new employer. Consider all your options and aim to let that money keep growing for your retirement, as it was meant to do.
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24. Look into side hustles
To help your 401(k) reach the million-dollar mark, you'll want to save aggressively. That's easier said than done, though, as few of us have lots of discretionary income. So look into how you might boost your income in order to permit hefty 401(k) contributions. Many people these days have side hustles -- at least for a few years. You might do a little driving for a ride-sharing company, do some freelance work on the side, tutor kids in a subject you know well, or sell crafts you make. There are gobs of possible side gigs.
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25. Live below your means
Having a good mantra can help you live frugally and reach your financial goals, so try this one: Live below your means. That means you'll need to know how much money you bring in and spend less than that sum each pay period -- perhaps with the help of a budget. Strategies for achieving this goal can include cooking more meals at home, not going to the local mall to shop for entertainment, and cutting off your cable subscription to stream videos instead. A little thinking can help you identify lots of ways to save a lot of money.
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26. Don't assume Social Security will provide enough
Don't assume that Social Security income will provide most, or even half, of what you want or need in retirement. The average monthly retirement benefit check was recently just $1,475, or about $17,700 per year. On average, Social Security is only designed to provide about 40% of our pre-retirement income. So it's vital to be planning, saving, and investing for your future.
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27. Be mindful of inflation
It's also important to keep inflation in mind as you plan and save for retirement. If you're 45 years old now and aiming for a million-dollar retirement nest egg, understand that if inflation averages 3% annually between now and your retirement in 20 years (and it has historically averaged about 3% annually), that million dollars will have the purchasing power of about $545,000. After all, something that costs you $100 today will cost you about $181 in 20 years if its price increases by an average of 3% per year.
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28. Aim for more than $1 million, if need be
That inflation factor means that you might need to save $1 million for retirement when you previously assumed that only $600,000 was necessary. Or, if you've been thinking that $1 million is what you need, $1.5 million or more might be more appropriate, depending on how far from retirement you are, how quickly you expect your money to grow, and how much income you expect from sources such as Social Security and pensions. For many people, $1 million isn't enough.
ALSO READ: Will $1 Million Be Enough in Retirement? It Depends Where You Live
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29. Keep your eyes on the prize
With your retirement plan in hand, stay the course over many years. Maintain your focus and discipline as you regularly sock money away and plunk it into effective investments. Take time to assess your progress every now and then, adjusting the plan as needed.
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30. Don't stop learning
Keep reading up on and learning about investing and retirement topics. Fail to do so, and you might lose your focus and fall into some ways to lose money, such as by speculating on penny stocks, borrowing money to invest on margin, day-trading, or trying to time the market.
For best results, keep learning. Learn about the greatest investors, and learn about great companies and their histories -- so that you might better spot new great companies in the making. Solid books about investing include The Little Book That Still Beats the Market by Joel Greenblatt, John Bogle's The Little Book of Common Sense Investing, Common Stocks and Uncommon Profits by Philip A. Fisher, and The Little Book of Value Investing by Christopher H. Browne. The more you know, the faster you'll likely hit $1 million in your 401(k).
Selena Maranjian has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
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