According to a retirement study released by Stanford University, only about 50% of American workers have access to a 401(k) or equivalent employer-sponsored retirement plan. And many who have a retirement account, aren’t making sufficient contributions to meet their targeted retirement goals.
Retirement savings is a life venture where the stronger you start — and the earlier it happens — the better you’ll finish. If you work for an employer and have access to a 401(k) plan, do all you can to maximize your contributions, especially while you’re young.
401(k) plans are one of the most generous retirement plans available. You can contribute up to $19,500 per year, or up to $26,000 if you’re 50 or older. You’ll also get a tax deduction for your contribution and full tax deferral on your investment income between now and retirement. Early in life, fund your plan with reckless abandon, especially if your employer offers a matching contribution.
How Much You Should Have in Your 401(k)
There’s no heavy science here, since much of the progress you’ll make with your 401(k) plan is dependent on your personal circumstances. However, there are general retirement savings guides to know, based on your age.
One way to gauge this is through the Fidelity Retirement Widget. When using this free tool, enter your age, your expected retirement age, and what you think your lifestyle will be at reach retirement. The results will show you how much savings you should have in your 401(k) plan at various ages.
For the example below, we input age 25, a retirement age of 67, and an average expected lifestyle.
| Age | Annual Income | Approximate 401(k) Income Multiple | Recommended 401(k) Balance |
| 30 | $50,000 | 1X | $50,000 |
| 35 | $65,000 | 2X | $130,000 |
| 40 | $80,000 | 3X | $240,000 |
| 45 | $100,000 | 4X | $400,000 |
| 50 | $140,000 | 6X | $840,000 |
| 55 | $150,000 | 7X | $1.05 million |
| 60 | $150,000 | 8X | $1.2 million |
| 67 | $150,000 | 10X | $1.5 million |
The recommended 401(k) balances are just approximations and can be adjusted higher or lower. For example, if you expect your lifestyle in retirement to be below average, the widget will recommend having 8X your annual income in your 401(k) plan at 67. If you expect your lifestyle to be above average, it will recommend 12X your annual income in retirement.
How to Manage My 401(k) Plan Investments
If you don’t know how to manage your retirement plan investments, that’s not a problem. There are services available to help you get the job done.
One example is Personal Capital. The free version comes with a 401(k) analyzer that discloses fund fees in your plan so you can switch to funds with lower fees. If you use the premium version, you’ll also get the 401(k) Fund Allocation, to help you learn where your money should be invested.
A more direct approach is available through blooom. For $10 per month, it provides direct management of your employer-sponsored retirement plan, whether it’s a 401(k), 403(b), 457 or Thrift Savings Plan (TSP). After a brief questionnaire, blooom sends you a recommended investment strategy for your plan. And since the service doesn’t actually take custody of your retirement account, you don’t need your employer’s approval to get started with blooom.
With the investment management services that are now available for 401(k) plans, lack of investment knowledge is no longer a reason to avoid investing through your retirement plan.
401(k) and Retirement Tips
Although the focus on retirement planning is almost entirely on the numbers, discipline and knowledge are equally important. When building your retirement plan, implement a few strategies.
1. Set Goals
You can certainly use the savings suggestions from the Fidelity Retirement Widget, but you need to work within the scope of your own financial circumstances. The important point is, whatever method you use, have goals in place. Those goals determine not only how much you’ll contribute to your plan, but also how aggressively you’ll invest the money.
For example, if you can’t make the full $19,500 per year contribution allowed, you might need to invest your plan portfolio more aggressively. One option is placing a higher allocation in stocks.
This strategy is recommended in the early years of your plan participation since you have more time to bounce back from aggressive investing. A popular rule for your stock portfolio allocation is calculating 120 minus your age. Here’s an example:
That means 95% of your retirement portfolio should be invested in stocks, and the remaining 5% in fixed-income investments. As you get older, the formula reduces your stock allocation as your investment time horizon shortens. The advantage of a heavier investment in stocks is that they’ve averaged 10% returns since the 1920s.
The larger stock allocation will result in a faster accumulation of investment earnings.
2. Start as Early as Possible
This is best demonstrated by two examples.
Investor A begins investing $10,000 per year into a 401(k) plan at age 25, with an average annual rate of return of 7%. By age 40, their plan accumulated $260,722 — but they stop further contributions.
Nonetheless, since Investor A continues earning 7% per year on their investment balance between the ages of 40 and 67, they reach retirement age with $1.62 million in their 401(k) plan.
Investor B begins investing $10,000 per year into his 401(k) plan at age 35, also with an average annual rate of return of 7%. Because Investor B started later than Investor A, Investor B plans to make annual contributions straight through to age 67.
But by retirement age, their 401(k) plan has grown to just $1,143,545.
Even though Investor B made $10,000 contributions for a full 32 years — while Investor A contributed for just 15 years, then stopped — Investor A still ended up with a larger 401(k) plan at retirement, and by nearly $500,000.
This example illustrates why it’s so important to start saving for retirement as early in life as possible.
3. Understand Your 401(k)
Not knowing much about 401(k) plans is perfectly understandable — after all, retirement savings isn’t a part of regular high school or college curriculums. Given that your 401(k) plan is your single biggest asset in life, and the very foundation of your retirement, it’s worth learning about this account.
First, information about your plan should be available from your plan administrator. You likely received a copy of it when you were first hired. Study the plan from cover to cover, and make sure you understand all the major provisions.
4. Never Touch Your Retirement Savings
For some workers, employer-sponsored retirement plans aren’t just their primary retirement savings, but their only savings. Borrowing against your retirement fund through a 401(k) loan, for example, might be tempting but you’ll hurt your long-term retirement plan.
The loans typically come with a five-year repayment period if you meet certain requirements, and have very low interest rates. But 401(k) loans have three very important “gotcha provisions”:
- You lose investment growth on borrowed funds. Once loan proceeds are removed from the account, they’re no longer being invested. You’ll pay interest of maybe 3% or 4%, which goes into your account, but that’s a lot less than the 7% or 8% you can earn in a balanced portfolio.
- You’ll have another debt to repay. You’ll ultimately have to repay the loan. Additional loan repayments on your monthly budget might reduce the amount of new funds you’re putting into your retirement plan.
- If you’re terminated, the loan is due sooner. You’re required to repay the full amount of the outstanding loan balance within 60 days, if you’re terminated from your employer. If you don’t, the remaining balance is automatically considered a taxable early distribution, subject to both ordinary income tax and a 10% early withdrawal penalty if you are under 59 1/2.
No matter how attractive the terms of a 401(k) loan may be, your best strategy is to pretend it doesn’t exist.
5. Don’t Rely on Social Security
One of the major reasons people don’t contribute enough to their 401(k) plans is an overly optimistic estimate of their anticipated Social Security benefits. Unfortunately, Social Security is not a retirement plan. It’s better described as a retirement supplement.
At most, Social Security supplies about 40% of your pre-retirement income, and that’s primarily for lower-income earners. If you’re at the higher end of the income scale (e.g. $100,000 per year) the percentage is much lower.
Use the Social Security Quick Calculator to get a rough estimate of what your Social Security benefit might be once you reach retirement. With this information on hand, you can better estimate how much money you’ll need to save in your retirement fund.
Frequently Asked Questions
Since the main purpose of a 401(k) plan is to replace your earned income in retirement, you’ll also need to increase your contributions. Of course, you won’t be able to contribute more than the maximum amount allowed by the IRS, plus any matching contribution from your employer.
If that’s insufficient, look into adding a traditional IRA or Roth IRA to your investment mix. Under either plan, you can contribute up to $6,000 per year, or $7,000 if you are 50 or older. Roth IRA contributions aren’t tax-deductible, but you can take income out of the plan tax-free at retirement.
One other major advantage with IRA accounts, whether traditional or Roth, is that you can open them through self-directed investment accounts. There, you’ll have unlimited investment options and you can invest as aggressively as you choose. You may find yourself getting a higher annual return on your IRA investments than you do in your 401(k) plan.
One other factor to be aware of as your income increases is that your 401(k) contribution may be limited if you’re defined as a highly compensated employee (HCE). Special rules will apply, and you’ll need to be aware of them as well as to create workarounds.
If your income declines, you’ll be forced to lower your standard of living. That means you’ll need less income in retirement and won’t need quite as much in your 401(k) plan either.
But this is another compelling reason to begin contributing to your 401(k) plan as early as possible. If you begin contributing to a retirement plan right out of college, you might have enough money in your plan by the time you reach your 40s to withstand an income decline and the lower 401(k) contributions.
There’s no simple or blanket answer. View your company’s stock the same way you would any other security you’re thinking about investing in. Ask yourself this question:
Would I invest in my company’s stock if I didn’t work for them?
If the answer is no, you should avoid it. And even if the answer is yes, be careful.
Holding a large amount of stock in the same company you work for may sound noble, but it also holds the potential for financial trouble. After all, the same pressures that might cause your employer to terminate your employment could also put downward pressure on company stock.
You’d be facing a double-jeopardy situation in which both your employment and your retirement plan would be at risk of loss.
Most financial advisors recommend you put no more than 10% of your plan into your employer’s stock. Again — If you wouldn’t invest in the company if you weren’t an employee, you might not want to go that high either.
Maximizing Your 401(k) Savings
How you approach your 401(k) savings strategy is unique to your personal financial situation. However, the key points to a sound retirement plan are:
- Participating in your employer’s 401(k) plan, if one is offered
- Contributing to the plan as early as possible
- Getting curious about your plan, and about how 401(k)s work
- Using a 401(k) management service, if you need extra guidance
- Setting goals and making adjustments along the way to stay on track
- Avoid borrowing against your 401(k)
If you follow these tips, you’ll be in a more secure place upon reaching retirement.
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