What is a 401K?
The 401k is an employer sponsored retirement savings plan. It allows employees to invest and save part of their pre-tax salaries. The money placed into the 401k is typically invested into mutual funds spread over stocks, money market, and bonds.
There are two major benefits of the 401k:
- Tax savings
- Employer contributions
The 401k Retirement Savings Potential
|Age||Years Worked||$ Low End||$ High End|
The table above shows a minimum and maximum potential earnings at a particular age. The numbers are based on a contribution of $8-18k at the age of 22, followed by an $18k contribution for each additional year. The "Low End" potential earnings column shows the total of contributions without compounding, whereas the "High End" includes compounded growth of 5-10%. For example, you start your job straight out of college and opt into the 401k retirement savings. You're able to invest the maximum of $18,000 by the age of 23.
Ideally, at age 23, you should aim to save $18,000 to make the most of your 401k retirement plan. Subsequently, at age 24 the total amount of your savings should, in ideal circumstances, be $38,000. This means an additional $2,000 earned from interest at the age of 24.
Let’s do a little math here. After working and saving $18k regularly for 43 years, you could end up with $3,500,000 in your 401k. Now if you live for about 15 years after retirement at the age of 65, you will have about $233,333 per year to live on. But life expectancy in the USA hit an all time high back in 2014 and is expected to continue rising. If you live up to the age of 90, it leaves you only $140,000 a year to survive on.
It is important not to ignore the time value of money. We are all well aware that inflation keeps undermining the value of a dollar with each passing year. So even if you have a spectacular total of $3,500,000 in your account 40 years down the line, it wouldn’t have the same purchasing power as it does now. With prices of food, medical, energy, and shelter always on the rise – thanks to inflation – who knows how much all this will cost 40 years from now.
Be Smart About It
The 401k plan may have a downside to it, but then what plan doesn’t?
The key to achieving a substantial retirement solution using the 401k lies in pitching every cent you possibly can into it. It would require you to plan ahead. Any major financial decisions, like buying a house or that boat you always wanted, should be taken on the basis of funds available to you AFTER you have paid your 401k contribution.
With the 401k, what you’re looking at is a lifestyle limited by financial constraints, but there’s a brighter side to it – you’d still be earning. On the contrary, imagine a scenario where you spend a lavish lifestyle while you’re young and capable of earning, only to be barely scraping through once you’re retired; you don’t want that!
The 401k allows you to save on a regular basis. This can make a powerful impact on your life after retirement. For example, Noel is 24 years old and his income does not permit him to invest the full 38k (max amount per the above chart) into his 401k account. He decides to invest $20,000 in his 401k on an annual basis and saves the same amount for 30 years. At the end of that period, his contributions would come up to a total of $600,000. That’s not all, he would be earning a return on that amount along with compounding interest year to year too; let’s say a modest return of 7% per annum on average + compounding interest – he’ll be a millionaire only 30 years down the line!
The 401k does reduce your day to day spending, however it can set you up for a very comfortable retirement. A smart investment strategy can help you gain maximum benefits from this particular retirement saving plan. So when it comes to answering the question:
How much should I invest at my age?
The answer is rather straight forward.
You should invest as much as you can at your age in your 401k account!