A million-dollar 401(k) account can provide a tremendous amount of financial security in retirement, but according to Fidelity, only 1.6% of accounts actually have a seven-figure balance in them. If your goal is to join this elite club, you don’t need to do anything extraordinary. The surest way to get to a $1 million (or more) in your 401(k) is to follow these three steps.
Start as soon as possible
When it comes to 401(k) investing, it’s important not to underestimate the value of time.
If your retirement savings account achieves an average return of 7% per year between now and when you retire, and you plan to retire at 65, this means that every $1,000 you save when you’re 45 can be reasonably expected to grow to about $3,900 by the time you retire.
Every $1,000 you save at 35 could grow to about $7,600. And every $1,000 you invest when you’re 25 could be worth $15,000 to your nest egg. In simple terms, you get more value out of the money you stash away early.
The sooner you max out your contributions, the better
Did you know that you can choose to contribute as much as $19,000 to a 401(k) in 2020? If you’re at least 50, the limit jumps to $26,000. The 2020 IRA contribution limit is $6,000 ($7,000 if you’re 50 or older), and you might be able to use both types of accounts.
You don’t necessarily need to contribute as much as legally possible to your retirement accounts. For many people, it wouldn’t be practical to set aside quite so much. Still, the point remains that if you want to retire as a 401(k) millionaire, you should be a little aggressive with your savings.
The most common 401(k) contribution rate is whatever the employer is willing to match. In other words, if an employer matches employee contributions up to 5% of their salary, employees will contribute exactly that much. That’s certainly a good thing, but it may not be enough to get the million-dollar nest egg you want. Retirement planners (myself included) typically suggest a target retirement savings rate of 10% of income – not including any employer contributions.
You don’t have to get there right away. One popular strategy is to increase your contribution rate by 1% each year until you reach your desired level. Or, try increasing your contributions by a little bit whenever you get a raise. Seemingly small increases can make a big difference over time.
Set your investments up for success
The third critical component of becoming a 401(k) millionaire is a solid investment strategy. You’ll notice that earlier I used an assumption of a 7% average annual return, which is a completely reasonable expectation for a properly allocated 401(k).
So what is a “properly allocated” 401(k)? The basic idea behind retirement asset allocation is that when you’re young, you put most of your money into stock-based investment funds (equities), which have excellent long-term return potential but tend to be quite volatile in the short term. As you age, you gradually shift assets into fixed-income (bond) investments. These don’t have as much return potential as stocks over the long run, but tend to be more predictable.
Asset allocation is a somewhat complex topic, and different 401(k) plans have different investment choices. Here’s a basic rule of thumb to know before you make your 401(k) investment selections: Subtract your age from 110 to determine the percentage of your 401(k) that should be in stock-based investment options. The rest should be in fixed-income investments. For example, if you’re 40 like me, this means you should aim for a 70% stock, 30% bond mix. When you’re 50, a 60%/40% allocation is more appropriate.
The bottom line is that the combination of investing early, investing aggressively, and investing wisely is the trifecta of building a million-dollar 401(k).
— Matthew Frankel
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Source: The Motley Fool