Is My 401k Enough For Retirement

What Kind Of Investments Are In A 401

401 accounts often offer a small, curated selection of mutual funds. Thats a good thing and a bad thing: On the plus side, you may have access to lower-cost versions of those specific funds, especially at very large companies that qualify for reduced pricing.

The negative is that even with discounted costs, that small selection narrows your investment options, and some of the funds offered may still have higher expense ratios than what youd pay if you could shop among a longer list of options. That can make it harder to build a low-cost, diversified portfolio.

Some plans also charge administrative fees on top of fund expenses, which can add up. If your 401 is expensive, contribute enough to earn your company match, and then direct any additional retirement savings contributions for the year into an IRA.

Why It Might Not Be

First, taxes. When you contribute to a 401, you’re getting a tax deduction today, but this doesn’t come without a catch. You won’t pay anything in taxes today, but you will be liable for taxes when you withdraw the money in retirement. If tax rates rise generally — and many signs point to just that — you might end up paying a higher tax rate in retirement than you would have if you had chosen to pay tax today. That said, this is incredibly difficult to predict.

Because we don’t know what’s going to happen to tax rates in the future, it might pay to consider other types of accounts with different tax treatments — like a Roth IRA or even an HSA — to hedge against future changes in tax rates. If you have money growing in a Roth IRA and a fully or partially funded 401, you’re prepared for whatever happens to taxes in the future.

Next, some 401s are incredibly expensive. This could mean your employer’s plan is held by a company that charges exorbitant fees, or it could simply mean the underlying investments in the plan come with high expense ratios. Either way, a costly retirement plan will ultimately cost you a significant amount. This makes other options more appealing.

The Power Of Compound Returns

The earlier you start saving for retirement, the less youll need to save each month. You can thank compounding, which is basically the returns you make on returns. Once youre making money on your earnings, your returns compound at an accelerated rate.

Suppose you want to retire at age 60 with $2 million and that you get average returns of 10%. Thats slightly less than what the S& P 500 index has delivered before inflation over the past 60 years with dividends reinvested.

Heres what youd need to invest, between your own contributions and your employers match, if you have a $50,000 annual salary.

• If you started investing at 20: Youd need to invest $316.25 per month, or 7.6% of your salary.
• If you started investing at 30: Youd need to invest $884.76 per month, or 21.2% of your salary.
• If you started investing at 40: Youd need to invest $2,633.76 per month, or 63.2% of your salary.

The examples above show not only how much more youll have to contribute to your 401 each month if you start saving later, but also how much more youll have to save overall. In the first example, youd invest just under $152,000 total by starting at 20. But if you didnt get started until 40, youd wind up investing more than $632,000 to reach your goal.

Keep in mind that 10% is an average, not the 401 rate of return you should expect every year. Your returns will vary, based on how your investments perform, along with the risk tolerance you indicate when you choose your investments.

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Are You On Track For A Millionaire Retirement With Only A 401

Workplace 401s are common retirement accounts. Many employers offer them, and investing in them is easy since money is taken directly out of your paycheck. Youll get tax benefits if you invest in one, and may even receive matching funds from your employer.

But is a 401 enough if you hope to become a millionaire retiree? Is it really possible to amass a seven-figure nest egg just from this account alone? Heres what you need to know.

Is Maxing Out Your 401 Enough Depends On How Much Income You Need In Retirement

Depending on your lifestyle, $65,000 per year may be enough to support your ideal retirement. Forecasting expenses in retirement is difficult, and some investors over-estimate how much theyll need to support themselves when they stop working.

However, individuals and couples with high incomes generally need more to maintain their lifestyle in retirement, especially if you dont want to rely on Social Security.

If the contribution limit on your 401 isnt enough to adequately fund your income goals, to help supplement retirement savings consider opening a brokerage account. A taxable investment account can help further a variety of goals, before or during retirement:

• Way to save after maxing out a retirement accountor sometimes instead of a retirement account
• Provide income for an early retirement or simply maintain their lifestyle in retirement
• Invest for pre-retirement goals like a home or college
• Create additional tax planning opportunities in retirement
• Invest extra cash flow or proceeds from selling a home or business
• Diversify after selling stock options or a concentrated stock holding

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Fees And Compounding Costs

The effect of administrative fees on 401s and associated mutual funds can be severe, and these costs can swallow more than half of an individual’s savings. A 401 typically has more than a dozen undisclosed fees, such as trustee fees, bookkeeping fees, finder’s fees, and legal fees. It’s easy to feel overwhelmed when you’re trying to figure out whether you are being treated fairly or being fleeced.

This is in addition to any fund fees. Mutual funds within a 401 often take a 2% fee right off the top. If a fund is up 7% for the year but takes a 2% fee, you’re left with 5%. It sounds like you’re getting the more significant amount. Still, the magic of the fund business makes part of your profits vanish because 7% compounding would return hundreds of thousands more than a 5% compounding returnthe 2% fee taken off the top cuts the return exponentially. By the time you retire, a mutual fund may have taken up to two-thirds of your gains.

Assumptions Made In The Hypothetical Analysis:

• Combined retirement savings through 2019 is $200,000
• Starting in 2020, both individuals max out their 401 contributions
• At age 50, the couple begins making catch-up contributions on top of their regular 401 savings
• The couple retires at age 65 with a life expectancy of age 90
• Analysis excludes state income tax and income from Social Security benefits
• Based on the risk preferences for the hypothetical couple, the asset allocation before retirement is an 85/15 diversified mix of stocks and bonds in retirement this drops to 70/30. Annual return and standard deviation assumptions were based on Morningstars long-term capital market expectations for the asset classes used in the analysis

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Tips For Getting Retirement Ready

• If youre unsure of what your retirement plans should look like, a financial advisor can help you get things in order. Luckily finding a financial advisor doesnt have to be hard. SmartAssets free matching tool can pair you with up to three advisors in your area. Get started now.
• Dont forget about Social Security. Youll get a check from the government each month, which can help you get to your desired retirement income level. Find out how much youll get with our free Social Security calculator.

Diversifying Is Usually The Answer

As a general statement, your 401 is one of the best options for housing your retirement savings. While it is most definitely a great start, it’s likely not sufficient on its own to optimize your position as a saver. Adding other accounts — most importantly, a Roth IRA — would be a smart thing to do given the uncertainty of future tax rates as well as the inflexibility of certain 401 plans. Make sure to cover all your bases and you’ll be far better off when it comes time to retire.

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Keeping Up With Inflation

Some annuities offer a guaranteed lifetime income with the ability to increase your income regularly to keep up with inflation. Once the income increases, the payment amount is locked in and can never go backward from that point forward.

Example

A 40-year-old purchases a $1,000,000 annuity with a lifetime income rider to retire at age 60. At age 60, the lifetime income amount may be guaranteed $105,380 initially but hypothetically increases to $288,439 by age 67. Once the income has increased to $288,439 annually, this payment is locked in and can never go below $288,439 in the future.

On the other hand, a performance-based annuity may hypothetically generate an income of $381,349 a year for life starting at age 60, increasing to $636,610 a year by age 70. Once the income has increased to $636,610 annually, this payment is locked in and can never go below $636,610 in the future.

K Savings Potential By Age

The following chart depicts 401k savings potential by age, based on several assumptions. So this is how much you could have saved. These numbers can seem high to many people, especially if you are older and started your retirement savings when the contribution limit was much lower. It can still be used as a guide for your target total retirement savings amounts, including your IRA, Roth IRA, and after-tax savings. While its designed for one person, it can also be used as a guide for a married couple if one spouse decides to no longer work.

The assumptions we used for this chart include:

*Generally, financial planners say the expected rate of return for a 401k is between 8% and 10%.

So, how do you stack up? Are you on the high end? The low end? Do you think these numbers are realistic?

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But How Much Is Enough

Our guideline: Aim to save at least 15% of your pre-tax income1 each year, which includes any employer match. That’s assuming you save for retirement from age 25 to age 67. Together with other steps, that should help ensure you have enough income to maintain your current lifestyle in retirement.

How did we come up with 15%? First, we had to understand how much people generally spend in retirement. After analyzing enormous amounts of national spending data, we concluded that most people will need somewhere between 55% and 80% of their preretirement income to maintain their lifestyle in retirement.1

Not all of that money will need to come from your savings, however. Some will likely come from Social Security. So, we did the math and found that most people will need to generate about 45% of their retirement income from savings. And saving 15% each year, from age 25 to age 67, should get you there. If you are lucky enough to have a pension, your target savings rate may be lower.

Here’s a hypothetical example. Consider Joanna, age 25, who earns $54,000 a year. We assume her income grows 1.5% a year to about $100,000 by the time she is 67 and ready to retire. To maintain her preretirement lifestyle throughout retirement, we estimate that about $45,000 each year , or 45% of her $100,000 preretirement income, needs to come from her savings.

How The Flexibility Of A Roth Ira Works In Your Favor

While your 401 plan might not have a lot of mutual funds to pick from, you can choose any of the thousands of existing mutual funds for your Roth IRA. How do you know which funds are right for your portfolio? Work with an investing pro you trust to help you weigh the pros and cons of different fund options.

With thousands of funds to choose from, you can select good growth stock mutual funds to build what the investing experts call a well-diversified portfolio to grow your retirement nest egg.

That might sound like boring investment lingo, but aside from increasing the amount you invest for retirement, spreading out your investments by selecting a balanced mix of mutual funds is probably the best thing you can do with your retirement savings. A Roth IRA gives you the freedom to choose a balanced mix of mutual funds for retirement: 25% growth, 25% aggressive growth, 25% growth and income, and 25% international.

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When Your 401 Just Isn’t Enough

Your 401 may fall short if you’ve already celebrated your 50th birthday without much savings to show for it. The challenge you’ll face is that annual contribution cap. After your 50th birthday, you can make catch-up contributions, which will help. In 2021, the catch-up contributions are $6,500. That increases your contribution limit to $26,000 annually.

While $26,000 sounds like a lot to save in a year, it’s often not enough for older savers. You have two factors working against you after 50. One, the investment timeline is very short, which limits your earnings potential. And two, as you near retirement, you need to start insulating your wealth from normal market volatility.

Let’s say you earn an average salary of $60,000 at age 50, and your employer matches 5%, or $3,000. With your maximum contribution of $26,000, you are saving $29,000 annually in total or about $2,400 monthly. That monthly contribution would grow to about $676,000 after 15 years — if you can keep that 6% growth rate.

The problem here is that planning for market-average growth is less reliable when you’re looking at periods shorter than 20 years. In any one year, the stock market might be up or down by double digits. If a down year happens just as you are about to retire, it would temporarily wipe out years of growth.

Your 401 Savings And Your Desired Retirement Lifestyle

How you want to live out your golden years is another huge factor in what your 401 savings will need to look like. Thats because retirement has evolved over time to become a more active time of life. Its now viewed as a new beginning to our lives rather than a beginning of our end. That shift in mindset has driven the need for additional sources of retirement income.

The Employee Benefit Research Institute study on the Expenditure Patterns of Older Americans shows that as we age our expenses decline. Using age 65 as a benchmark, the study found that household expenses drop by 19% by age of 75 and 34% by age 85. The study also found that people over the age of 50 spend 40-45% of their budget on their home and home-related items. The bottom line is that by the time we retire our expenses are down between 20% and 40%. This is why expert opinions differ on how much of our pre-retirement income we need. Guidelines generally vary from 60% to 80%.

If you have a household income of $100,000 when you retire and you use the 80% income benchmark as your goal, you will need $80,000 a year to maintain your lifestyle. Assuming your 401 savings grow at 8%, you should expect to have up to $80,000 a year in interest income so you can avoid having to touch your principal as much as possible.

Retirement Savings Options Beyond A 401

Given the limits on a traditional 401, what are some options that can help generate reliable, tax-efficient income in retirement?

A Roth: A Roth account is a version of a 401 that many companies offer. You can also open a Roth IRA on your own . A Roth account is the opposite of a traditional 401 or IRA from a tax perspective. With a Roth, your contributions have already been taxed, so you typically wonât owe any income taxes in retirement on your distributions. And, just like a traditional account, your savings grow tax free.

The utility of a Roth really shines when you get to retirement, because it gives you a little more flexibility with your taxable income. Thatâs because you can mix and match taxable and tax-free distributions from your traditional 401 and Roth, respectively, to reach your income goals but also land in a desired tax bracket each year.

A Traditional IRA: A traditional IRA is very similar to a traditional 401. If you donât have a 401 or you have maxed out your 401, you could contribute to a traditional IRA. IRA contributions are also capped yearly . Just remember that the contribution limits are a total for Roth and traditional. That means you could contribute $3,000 to a Roth IRA and $3,000 to a traditional IRA in a year, but not $6,000 to both.

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The Best Course Of Action

No matter how old you are, the best way to improve your retirement readiness is to extend your investment timeline. There are only two ways to do that. You can save more today than you did yesterday, or you can delay retirement.

You can’t predict the future of your health or your career, however. So the more reliable option — by a long shot — is to save more now. That means your next move, after you polish off that donut, is to log into your 401 and raise your contribution rate.