Owning Your Retirement

The 401(k) is not very old. Younger than me, actually, turning 40 years old just this year.  The first generation of individuals that have been forced to save for and create their own personal retirement programs are just starting to cross the finish line.

Almost by accident, section 401(k) of the Revenue Act of 1978 has become the default option for the working men and women of the United States.  Employee benefits consultant Ted Benna referenced using section 401(k) in 1980 as a way to create a new benefits package to defer taxes on portions of an employee's income, and in 1981 the IRS issued rules allowing payroll deductions for 401(k) accounts.  In two years, more than half of the companies in the country were offering 401(k) plans or considering it.

This is mostly to say that we don't have a ton of research on how well people do planning their retirements without the benefit of a pension plan.  The concept of "doing it yourself" is just so new.

Ben Carlson from A Wealth of Common Sense had a piece this week on how hard it is to become a 401(k) millionaire.  There's a lot I want to unpack on this concept, so let's jump in.

Do You Need a Million Dollars to Retire?

First and foremost, let's tackle the elephant in the room.  Do you need to have a million dollars to retire?  The answer to that, no matter how big that number may seem, is dependent on how much money you're going to need to live off when you decide to become financially independent or retire from the workforce.

One basic rule of thumb you can use to figure out how much money your savings can generate safely in retirement is to multiply the balance by 4%.  A million dollars, in this case, would generate $40,000 per year using the 4% rule.  You can also work this calculation backwards and figure out how much money you think you need annually to pay the bills and then multiply that by 25.

Let's say you think you'll need $75,000 per year in retirement for you and your spouse.  You multiply $75,000 by 25, and you get $1,875,000.

It's crude and there is a lot more work that needs to go into putting together an actual plan (obviously, there is more to factor in, including social security and other potential income), but it gives people a good framework to create their own retirement target in their heads. 


Becoming a 401(k) Millionaire

Given that backdrop, let's get to the meat of Ben Carlson's article - how hard is it to save a million dollars in your 401(k)?  Again, the answer to this question is dependent on a lot of different factors.

Several things will help, and the most important is saving as much as you can and starting as early as you can.  Maxing out your contributions is no easy feat.  Current law allows us to put up to $18,500 per year into our 401(k) accounts, not including a company match.  To put that number in perspective, a healthy savings rate is typically 10 to 15% of your income. 

On a salary of $125,000 per year, saving 15% of your paycheck would allow you to max out your contributions. 

Here's a table of the investment returns that would be required at different starting points to help you reach that milestone of becoming a 401(k) millionaire.

Again, as I said, no easy feat.  Vanguard published an incredibly absurd statistic saying that "only" 4% of individuals making $50,000 per year were maxing out their 401(k) contributions.  My response -  how in the hell can you do that making only $50,000 per year?  That's a savings rate of 37% of your gross income.  Needless to say, you wouldn't have much left to actually eat and pay rent.

"The numbers I ran here make it seem like it shouldn’t be that hard to save at least $1 million by retirement age. But everything looks easier on paper than in real life, especially when money is involved. Saving, investing and getting your personal finances in order is always more of an exercise in psychology than math. It would be irrational of me to suggest that 'everyone' should be able to be a 401(k) millionaire because getting your finances in order is no easy task." ~ Ben Carlson

So what can you do?

None of this is supposed to scare you, but it is supposed to douse you with a heavy dose of cold water and wake you up to the reality of preparing for a day when you won't want or need a regular paycheck as part of the workforce.

What can you do to get yourself on the right path?

1. Save money.  If you aren't putting away 10% of your income into your 401(k) account right now, figure out how to make that change as soon as possible.

2. Increase your savings rate every year.  Once you get to 10%, you need to work on getting to 15%.  Increase your contributions every year by 1%.

3. Have a plan for your investment choices.  Do some research.  Ask for help.  No matter the investment choices you are presented with, you can create a solid investment policy and then you need to stick to it.

4. Get some help.  Find someone you trust that will provide you fiduciary financial advice (meaning transparent and free of conflict) and not someone trying to sell you an investment or insurance product you don't need.

Happy Monday to all of you and, as always, thanks for reading.  Go be great this week and be kind to someone who needs it most.