Fidelity Investments reported that the number of 401(k) millionaires – investors with 401(k) account balances of $1 million or more – reached 233,000 at the end of the fourth quarter of 2019, a 16% increase from the 200,000 count in the third quarter and an increase of more than 1000% from the 2009 count of 21,000. Joining the ranks of the 401(k) millionaires is actually quite achievable, but you need to be consistent, patient, and appropriate in your investment choices.
Key learning points
- Start contributing to a 401(k) plan as early as possible.
- Contribute regularly and at the appropriate level.
- Be hands-on in terms of your investments within your 401(k), and don’t be afraid to take risks, especially when you’re young.
Consistent and sufficient contributions
Becoming a 401(k) millionaire comes slowly, similar to training to run a long-distance race. When you first become eligible to contribute to a 401(k) plan, contribute as much as you can. If your employer offers a match, contribute enough to earn the full match. Failure to do so will leave free money on the table.
The key is to start early. Even if you can afford to contribute 3% of your salary, start now. Try increasing that to 4% or 5% the following year and every year until you approach the maximum contribution limit. For 2021, the limit is $19,500, with an additional $6,000 catch-up fee for those over 50 at any time of the year.
Invest the right way
Select your 401(k) account investments based on your financial goals, age, and risk tolerance. The general rule is that the longer you have until retirement, the more risk you can take. If you don’t take the right risk, your account won’t grow as fast as it could.
There are countless stories of plan participants in their 20s with all or a large percentage of their account in the money market or their plan’s stable value option. While these options are low risk, historically they have not performed as well as stocks in the long run.
When changing jobs, don’t ignore the 401(k) at your old employer or growth may suffer.
Don’t neglect old 401(k) accounts
If you’ve changed jobs, you’ll need to decide what to do with 401(k) accounts with old employers. You have several options: transfer the account to an individual retirement account (IRA), leave it in the old plan, or roll it over to the new employer plan.
How you transfer money from existing accounts to a new account has tax implications. Because the money contributed to a 401(k) is tax-deferred, withdrawing the money and failing to deposit it into a new tax-deferred retirement savings account within 60 days can result in taxes owed, plus an early withdrawal penalty of $10. % if you are under 59½. Instead, use an instant rollover to avoid paying taxes or penalties for the withdrawal.
The most important thing is to keep following this money. As your career progresses and you have more employers, it can be difficult to remember where all your assets are. Whatever choice you make now, you may want to consolidate them with other retirement accounts later to make your money easier to manage.
How do you become a 401(k) millionaire?
Target date funds are not a magic bullet
Target date funds are typically mutual funds with a mix of stocks, bonds and other investments. They can be a ready-made option for retirement savers as they base their aggressiveness on the target retirement date. Target date funds are often offered as a default option by plan sponsors when employees are not making their own investment choice.
Because target date funds provide you with a diversified portfolio, they can be a good option for younger investors, who may not have other investments outside of their 401(k) plan. However, since you are building diversified investments outside of your 401(k), you may want to consider adjusting your 401(k) investments to suit your overall investment situation.
One of the big selling points touted by target-date fund issuers is the sliding slope. If you are decades past retirement, the fund will hold more growth-oriented investments. As you get closer to retirement, the fund will move towards a more conservative mix of investments. Before deciding whether or not it’s right for your retirement situation, make sure you understand the glide path for any target-date fund you’re considering. And pay attention to the fees, too: Some target-date funds cost more than other good retirement options, such as index funds and ETF funds.
The value of financial advice
As you get older, the assets you manage will likely become more complex and may include your IRAs, annuities, a spouse’s retirement plan, a pension, taxable investments, and other assets. Hiring a financial advisor to help you view your current 401(k) plan in the context of these other investments can help you get the most out of your 401(k).
Many plans offer participants access to investment advice, sometimes for a fee, through their plan provider or online services. The quality of this advice varies, so do your homework ahead of time. Ask whether the advice takes into account any external investments and your overall situation.
It comes down to
Taking early and continuous action throughout your working life is essential to maximize the value of your 401(k) account and become a 401(k) millionaire. Contribute consistently, invest appropriately for your situation, don’t ignore your old 401(k) accounts, and seek advice when needed.