|Seven Swell Strategies To Maximize Your 401(k) Plan
- Start saving early
- Maximize your contributions
- Learn about your investments and be shrewd about your choices
- Look at the long term
- Always keep your money working
- Work as long as you can
- Diversify your portfolio
Retire as a millionaire!
That's the American dream. It's one Knute Iwaszko attained in about 15 years. Before you start thinking Iwaszko was a Wall Street whiz with a huge salary, he wasn't. He says he saved for retirement while earning $60,000 a year and paying the costs to raise five kids.
How did he do it?
He had a plan. First, he taught himself the fundamentals of budgeting and saving in his 20s. He learned how to cope with routine and unexpected expenses and still have enough to set aside for retirement. Then, he invested early and often in his employer-sponsored 401(k) plan. He made it the cornerstone of his retirement fund.
In the early 1980s when 401(k)s first became available, Iwaszko, who was in his early 40s, started stashing money away. Meanwhile, he was also shoveling money into an individual retirement account. "When I left the company (at age 59), I was in for 15 years. At that point, I had almost $1 million," Iwaszko said. He had about $800,000 in his 401(k) plan and about $200,000 in an IRA.
That was five years ago. Iwaszko hasn't had to even touch his 401(k) money, in part, because of the success of the book he wrote about his retirement savings experiences titled: "The 401(k) Millionaire: How I Started with Nothing and Made a Million - and You Can, Too."
How do you get there?
We'll take a look at how much you should be setting aside in your 401(k) plan so you can get close to this dream-like figure. Along the way we'll offer a few tips on how to make your retirement money work harder for you.
Make Your Money Work For You
Reaching $1 million seems like a pretty daunting proposition if you expect to set aside each one of those dollars from your own pocket.
The key is learning how to make your money work for you. The tool you use to do this is called compounding. When you compound your money, you take the interest you earn and plow it back into your account. Then, the next time interest is added, it's on the new, larger total. With compounding your savings grow exponentially. The longer you leave your money in your account the more it grows.
Rule of Thumb: You can use what is known as the Rule of 72 to help show how compounding works. It helps you figure how long it will take to double your money if you're investing at a fixed rate of return. It works like this: take 72 and divide it by the interest rate you're getting. If the rate is 10%, it will take 7.2 years to double your money. If the rate is 20%, your money will double in 3.6 years.
"For younger Americans, (compounding) is an ideal situation," said Diane Gallagher, manager of participant communications with J.P. Morgan/American Century Retirement Services. "They have all the benefit of time to make their money work."
How To Get $1 Million In Your Account
Here's what it takes to get $1 million into your 401(k) account. Let's start with some basic assumptions: a 10% annual return. (There's no assurance that today's healthy economic conditions will continue forever.)
Let's also assume, you will pay an effective tax rate of 15% when you retire. Often when you retire your income drops and you pay a lower tax.
If a 20-year old started with nothing and invested $3,000 a year for 45
years, the fund balance would grow to $1,351,591 by retirement at age
If a 30-year old started with nothing and invested $6,000 a year for 35
years, the fund balance would grow to $1,156,210 by retirement at age
As you can see, all it takes is a little discipline and time. "If (people start saving) in their 20s or 30s, most people see substantial income by the time they're retired," said Hal Ratner, director of fund analysis with 401k Forum.
Even if you're a little older, you can still make this work for you.
If a 40-year old started with nothing and invested $12,750 a year for 25
years, the fund balance would grow to $1,003,014 by retirement at age
If a 50-year old started with nothing and invested $35,500 a year for 15
years, the fund balance would grow to $1,002,246 by retirement at age
If a 60-year old started with nothing and invested $175,000 a year for
five years, the fund balance would grow to $1,036,940 by retirement at
"As you get older, it takes a lot more to catch up with the youngsters. But, don't be put off," said Ted Benna, the benefits consultant who designed the first 401(k) plan. "Anything is better than saying it's too late. (Older people) need to get saving as much as they can and increase it as soon as it is possible."
That may mean trimming back on some of life's luxuries. Instead of buying a new SUV, you might want to buy a used car and put the extra money in your retirement account, Benna suggests.
Here are seven strategies we've culled from various experts to help you get the most out of your 401(k) plan. You can find more information and books on this topic at your local or on-line bookstore.
1. Start saving early and be consistent, Benna says in his book, "Escaping The Coming Retirement Crisis." Doing this will help you reduce the risks you face in the markets. By starting early, your money has more time to grow through compounding. Also you'll have more opportunity to recover if the market takes a downturn. Further, you'll be able to use an investment technique known as dollar cost averaging. The idea is that by contributing a fixed sum regularly your results will be more certain. You don't have to worry about trying buy when stocks are low and selling when they are higher.
2. Maximize your contributions. Currently, the law allows employees to contribute a maximum of $10,000 a year.
Helpful Hint: If you're strapped for cash and can't contribute the maximum, at least put in enough to get your company's full matching contribution. Not taking advantage of the full match is like "walking away from an automatic return," Gallagher said.
The average match is 50 cents on the dollar for the first 6% of your salary. Not all companies have a match. Even so, you can put aside more tax-sheltered money in a 401(k) plan than you can in an IRA.
3. Be shrewd in choosing your investments and learn about them.
Read the financial pages in the newspaper to find out which of your investment options are consistent winners and which are losers. Don't put your money in the latter, Benna advises. He also urges employees to avoid funds with high commissions, pick established fund companies and avoid funds that put all their money in one industry.
Indeed, Iwaszko didn't build up his $1 million balance by chance. He studied the market very carefully. He read all of his statements and used them to figure out which funds were doing well and which ones weren't. From there he adjusted his portfolio. Long before he even had a chance to contribute to a 401(k) plan Iwaszko joined an investment club. That taught him how to research his investments.
4. Look at the long term and understand the risk of being too conservative.
When you have a time horizon of 10 years or more, you'll need to adopt a modest to aggressive strategy in order to beat inflation and build up an adequate nest egg, Benna says.
"I started at 40," Iwaszko said. "I became very aggressive." He put all his money in stock funds, which in turn benefited from a great bull run in the stock market. Of course, there's no guarantee that such a bull run will be replicated in the future.
|(Source: J.P. Morgan/American Century Retirement Plan Services)
His style may not be yours. Take the time to sit down and honestly assess your risk preferences. If you have 30 years before you retire, you can be more aggressive about your investment choices. The higher the return, the more you make. If you have a shorter time horizon, say five years, you may want to invest more conservatively.
Click here to read more about how to allocate your money.
5. Always keep your money working. Compounding works best when the money stays in the account. Compounding loses its power if you take money out of the account before you retire. "Using your retirement plan for short-term needs could impact your (ending) balance," Gallagher said.
Indeed, Iwaszko says he never took a loan against his account.
Helpful hint: If you put money in an IRA, contribute at the beginning of the year, rather than at the last possible date. The reason: you earn more interest. That can add up to some serious dollars. Suppose you put $2,000 a year into your IRA on January 1999 rather than April 15, 2000, the last time you can shelter money for the 1999-tax year. Let's also assume you can earn an 11% return on your money. Over a 40-year time frame, giving that money an extra 15 months to work can earn you an additional $162,362. "At 11% over 40 years, it makes that big of a difference," Iwaszko said.
6. Work as long as you can, Benna advises. Often when people decide to take early retirement, they underestimate how much they'll need to live on or how much their savings will last. Working longer gives your life more meaning and gives you more time to build your nest egg.
7. Diversify your portfolio, Benna advises. The reason for doing this is that if you have money in a variety of investments and one goes down, you won't lose everything.