By Philip Piedt, CFP®
Everyone likes the idea of being a millionaire one day. Becoming a millionaire is part of the proverbial American Dream, alongside owning a home with a white picket-fence, two cars in the driveway, and being able to wave to your neighbors, the Joneses. The idea of retiring rich with one million dollars in your retirement account sounds sweet, right? But is it feasible?
Most Americans are offered a 401(k) plan through their employer and use that as their primary vehicle for retirement savings. In fact, after three decades since its inception, the 401(k) is America’s number one way to save for retirement.1 There has been a growing decline of employers not offering a defined benefit or pension plan. Alternatively, employers are now offering a defined contribution plan, such as a 401(k) plan, with an incentivized matching contribution.
As the 401(k) has aged and grown in popularity, an elite few participants have started a new breed of retirement investors – the 401(k) millionaire. Yes, seven-figure 401(k)s are rare. The Employee Benefit Research Institute (EBRI) reports nearly 1% of all 401(k) accounts are a million dollars, but they do exist.2 According to Fidelity, one of the largest providers of 401(k) plans, the number of million dollar 401(k)s has more than doubled since 2012, exceeding 72,000 at the end of 2014.3 Workers with higher-figure salaries definitely have one leg up, but not all members of this exclusive club are making the big bucks. To join this group, you have to do as the pros do.
Here are eight secrets to becoming a 401(k) millionaire.
1) Begin Saving Early
As the old adage goes, the early bird catches the worm. No case could be more accurate than when it comes to your retirement savings. The earlier a saver starts socking away money through their company 401(k) plan, the longer the time horizon their savings has to grow. As Albert Einstein once said, “The most powerful force in the universe is compound interest.” If you have age on your side and just became eligible for your employer’s 401(k) plan, take full advantage and contribute something. A little savings can go a long way over a 30-40 year timeframe.
2) Boost Savings Over Time
How do you attain a million dollar 401(k) at retirement? Just like eating an elephant – one bite at a time! One way to achieve retirement savings over time is through gradual increases in your salary deferment. In 2015, you can contribute up to $18,000 per year in your 401(k). If age 50 and older, you can put in an additional $6,000 as a catch-up contribution.
Some employers automatically enroll employees in their retirement plan and defer 3% of their salary. Each year, the contributions automatically increase by 1% unless the employee elects otherwise. While most financial planners believe you should save 10%-15% for retirement, this method softens the blow to your net paycheck while not forgoing savings. Another recommendation is deferring your annual salary adjustment or bonus if you receive one. As your income increases, human nature is to spend more. Instead, if you can continue to live off your existing pay while saving more, this only boosts your retirement account balance. Money you don’t see, you don’t miss.
3) Milk Employer Contributions
Another great way to increase your chances of having a seven-figure 401(k) is to take full advantage of your employer’s matching contributions. According to the HR association WorldatWork, a third of companies, half of workers don’t contribute enough to their 401(k) to receive the full employer match.4That is a hefty missed opportunity to collect on free money. Common matching contributions are .50 cents for each dollar you contribute, up to 6% of your salary, or dollar for dollar up to 3%. Those contributions are 50% and 100% returns on your money, respectively, before even investing! Whatever the match, capitalize from your employer or else it is money you’re leaving on the table.
4) Pay Off Consumer Debt
Those who are 401(k) millionaires create long-lasting and satisfying retirements for themselves by living well within their means and saving as much as they possibly can. One thing they’re not accumulating? Debt. In 2015, the average American household carries a credit card balance of $7,281. 5If your retirement was a summer block-buster action film, the 401(k) would be the super-hero and debt would be the villain. Debt can lure you in through consumerism and instant gratification. Credit cards with high APRs, absurd monthly car payments and every other tantalizing debt in between will restrict you and your retirement saving super-powers. Devise a re-payment plan and attack your consumer debt so you can then fully focus on paying your future-self as opposed to a lending institution. Your future-self thanks you in advance.
5) Consider Your 401(k) Off Limits
A remarkable 20% of 401(k) savers borrowed against their plans in 2013 according to EBRI.6 Borrowing against your retirement becomes very tempting when you want to buy that new boat or put a down payment on your first house, especially when you have a fat and happy 401(k) balance. The problem is that doing so may result in serious ramifications for your future. These 401(k) loans create unnecessary fees in your account, statistically give you a higher propensity of saving less and can cause serious taxable consequences if you don’t pay the loan balance in full. A pre-cautionary step against going into debt through a 401(k) loan is having a liquid, well-funded and accessible emergency fund. There are no second chances when it comes to retirement. Consider your 401(k) untouchable and non-negotiable.
6) Consolidate Retirement Plans
What’s worse than borrowing against 401(k)? Yes, you guessed it, cashing it out when leaving your company. This event triggers income taxes plus an additional 10% penalty if you are younger than 59 ½ years old. Ouch! This is the IRS’s way of saying, “Don’t touch your retirement account!” An easy solution to avoid this is rolling over your old 401(k) into your current employer’s 401(k) plan. If your new employer does not offer a retirement plan or you’re transitioning into retirement, you can always rollover your plan into an Individual Retirement Account (IRA). This allows you to consolidate multiple retirement plans from past employment into one single retirement account for simplification and ease of management.
7) Monitor Your Investments
An intense saver maxing out their 401(k) and a generous employer match might not be enough to make it to the elite millionaire club in itself. 401(k) millionaires do their homework and monitor their investments on a frequent basis. This does not mean day-trading your 401(k) based on what you hear from your mailman. You need to be an informed and active investor with your retirement using these three R’s: Research the investment funds offered in your plan’s design. Review your investment mix based on your risk tolerance and financial planning goals. Rebalance your portfolio periodically to its original allocation. If you retain a financial planner on a fee-basis, request their input on your 401(k) investment selection. They should want to review this if they manage your other assets.
8) Don’t Forget About Uncle Sam
One common mistake investors make as they near retirement is failing to take taxes into consideration. Most of your 401(k) money is probably from pre-tax contributions and as soon as you begin taking withdrawals, Uncle Sam wants his piece of the pie. Traditional advice suggests postponing 401(k) withdrawals as long as possible by first liquidating after-tax accounts. However, with a million dollar 401(k) balance, income from distributions might push you into a higher tax bracket. One alternative strategy can be taking distributions in years you know your income might be less. This is particularly helpful for those who are working in their late 60’s and have not taken Social Security. Another option is considering a Roth conversion. Taking advantage of low income years to convert IRA money to a Roth can cut your tax bill over time.
Of course, these strategies are based on your particular financial situation and call for advice from your accountant or financial advisor. After years of vigilant saving and investing, you do not want to jeopardize your million dollar 401(k) by ignoring or making bad tax moves. After all, who wants to keep up with the Joneses anyway? They’re broke.
For more questions on how to become a 401(k) millionaire, contact Philip Piedt, CFP® at [email protected].
About the Author:
Philip Piedt is a Certified Financial PlannerTM (CFP®). He was among the youngest professionals in the United States to earn the CFP® designation. Piedt also holds the Series 7 and 66 registrations and Life, Health & Variable Annuity licenses. He leads the foundational planning division of Benchmark Financial Group, LLC, where he is primarily focused on families and business owners in the early stages of their financial life.