401(k) accounts are powerful savings tools because they’re easy to sign up for and making automatic contributions to them is just a matter of filling out a little paperwork at work. But if you want your 401(k) to turn into an account that can support you throughout the entirety of your retirement, you need to employ the right strategies with it.
The good news is, it’s not hard to turn your account into a big pot of money that will give you the financial security that you deserve in your later years. In fact, smart 401(k) investors can employ some or all of these five simple strategies to end up with a million or more in these tax-advantaged accounts by retirement age.
1. Max out your employer match
For example, you might be offered a 50% match on contributions up to the first 6% of the salary you earn or a 100% match up to 4% of your salary.
Whatever the amount of your match, you need to contribute enough to max it out if you want to maximize the chances of ending up with a 401(k) worth millions.
After all, there aren’t too many opportunities to earn a 100% return on investment, and you can’t pass them up when your goal is a seven-figure account balance.
2. Make use of the Saver’s Credit if you’re eligible
The Saver’s Credit exists to help lower-income and middle-class Americans save enough for a secure future. It’s a tax credit that gives you back anywhere from 10% to 50% of the first $2,000 in contributions to your 401(k) or other eligible retirement account. The specific amount of your credit will depend on your income, but for singles with an adjusted gross income of $19,500 or under, it’s worth up to $1,000. For married couples with an AGI of $39,000 or less, it’s worth up to $2,000.
Just like your employer match, you have to contribute money to your 401(k) to take advantage of this credit. It’s also free money, because a credit reduces your tax bill on a dollar-for-dollar basis. If you were going to owe $1,200 in taxes and you invest $2,000 in a 401(k) to claim the full Saver’s Credit of $1,000 as a single person, your bill to the IRS will go down to just $200. You’ll have put an extra $2,000 into your 401(k), but it’ll have cost you only $1,000 out of pocket with the government making up the difference.
3. Claim all the free government help you can afford to
While the Saver’s Credit is only for those who are eligible based on income, everyone with access to a 401(k) can get some free help from Uncle Sam in building their retirement nest egg. That’s because you can make pre-tax contributions to your 401(k) of up to $18,500, or $26,000 for those over 50 who are eligible to make a $6,500 catch-up contribution (these are the limits for both 2020 and 2021).
A tax deduction isn’t as valuable as a credit, as it only reduces the amount of income you’re taxed on. But you can still score a lot of essentially “free” money by claiming it, especially if you can max out your 401(k) or get as close to doing so as possible. Say you’re over 50 and you make the maximum $26,000 contribution. If you’re in the 24% tax bracket, that contribution could save you up to $6,240 in taxes, so it would essentially only cost you $19,760 in the year you invest the money.
Of course, you eventually have to pay taxes when you withdraw money from your 401(k) as a retiree, but you can enjoy tax-free growth in the meantime, and you may be in a lower tax bracket later in life when the bill comes due. The government subsidy that comes from the tax savings in the year you contribute makes it much more likely you’ll amass a nest egg of $1 million or more — especially if you contribute the maximum and get the full amount of “free” money from the government that you can.
4. Set up a percentage-based contribution
If you can’t afford to contribute the maximum to your 401(k), you’ll have to decide how much you do want to put in the account. In many cases, you’ll be given a choice between contributing a flat dollar amount (such as $400 per month) or contributing a percentage of your income (such as 10%).
If you choose the flat dollar amount, the contributions you make won’t go up as your salary does unless you take action. But if you opt for a percentage-based contribution instead, the amount you’re saving will increase along with your wages. If you were previously making $50,000 and contributing 10% of your income, and you get a raise and are now making $52,000, you’ll be contributing $5,200 instead of the $5,000 you were investing before your salary bump. That automatic increase wouldn’t happen if you’d instead simply requested $5,000 worth of contributions be withdrawn over the year.
5. Bank your raises before you spend them
Speaking of raises, most often when people get them, they simply expand the amount they spend to account for their new higher paychecks. If you’re hoping to amass millions in your 401(k), don’t do that. Instead, as soon as your salary is increased, raise your 401(k) contributions. Ideally, you’ll increase them by the specific amount of your raise, so your paycheck stays the same but more money goes into your retirement account — but if you need some of that extra cash, you could opt to bank half the raise.
By investing your raises, you can increase the amount you’re saving for your future without making drastic changes to your lifestyle that may not be sustainable. It’ll maximize the chances of amassing millions, especially if you keep doing it until you’re maxing out your account or contributing at least 20% of the income you earn.
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Source: The Motley Fool