Let’s talk about retirement. It’s not something people give much thought to. Especially if you’re a young adult in your 20s. It’s not a popular topic since no one wants to think about growing old… Let alone retiring.
In fact, 64% of Americans aren’t prepared for retirement. And shockingly, 48% don’t care for it altogether according to this study.
So what are your plans? And do you know if you’re saving enough money for retirement?
If you feel discouraged as you try to answer these questions, you don’t have to feel alone.
The average 401(k) savings for people between ages 60–69 is only $171,400 according to research.
This is nowhere close to enough for retirement. Assuming that you live until age 80, $171,400 only gives you about $11,426. Even if you add social security income of $37,356 a year, it will only net you about $48,782 yearly for 15 years.
If you live past 80, your 401(k) will run out and you’ll most likely have to depend on your social security income alone.
I know this statistic sounds depressing. But here’s the truth about planning for your retirement. Retirement planning doesn’t have to be stressful or intimidating.
There’s Still Hope for Your Retirement
Here’s something they don’t teach you in school. Anyone can learn how to make retiring with a million dollars easy and automatic. All you need is a job that pays $35,000 or more with a typical 401(k) plan.
I know what you might be thinking. This sounds too good to be true. How can anyone with such a low salary retire as a millionaire? Believe it or not, it’s as simple as contributing 10% of your salary every year to your 401(k). Do you still feel lost? Then let me explain.
To get my point to make sense, let me explain what a 401(k) is.
It’s an investment plan geared towards your retirement savings. And to keep things simple, I’ll focus on the traditional 401(k).
What is a Traditional 401(k)?
A traditional 401(k) is a retirement account that takes a percentage of an employee’s income and invests them into mutual funds. It allows employees to contribute up to $19,500 per year for those under the age of 60.
If you’re past 60 years old, you can contribute an additional $6,500. A traditional 401(k) also allows you to earn and save for your retirement without getting taxed until you withdraw from your account.
On top of tax advantages, employers will match a percentage of your contributions dollar for dollar. So how does this work? Let’s take a look at the most typical 401(k) program available.
A typical 401(k) plan matches 50 cents per dollar, up to 6% of the employee’s salaries. Simply put, this means that if an employee contributes 6% of their pay into their 401(k) account, the employer contributes an additional 3% into the account.
So let’s say your annual income is $35,000 and you contribute 6% of it, which is $2,100, your employer would match half of it, which adds $1,050 to your account. It’s essentially free money.
What’s most important is that if you play your cards right with your 401(k) program, you can retire comfortably. Assuming that you have a stable career throughout your life with a typical 401(k) plan, you won’t have to worry about money in your retirement.
So aside from long-term advantages, I’ll explain the immediate tax benefits of contributing 10% of your income to your 401(k) next.
Immediate Tax Advantages of 401(k) Contributions
Now, you might be thinking that you can’t afford to put away 10% of your income to retirement. After all, paying the bills alone is hard enough. So how can anyone afford to put away 10% of their income?
So here’s the gimmick. A traditional 401(k) lets you make tax-deferred contributions to your retirement.
The keyword here is tax-deferred. This might sound like some fancy financial lingo but don’t let this scare you. This just means that you can make contributions towards your retirement without paying the taxes on it until you withdraw from your account.
So let’s explore the tax advantages of contributing 10% at an income level of $35,000 per year. This means that you put away $3,500 into your 401(k) account each year.
This will decrease your reported income on your tax returns down to $31,500. So what does this mean for your taxes? It means that your taxes will decrease since you’re only being taxed for $31,500 instead of $35,000.
Without any 401(k) contributions, you’d normally pay $2,495 in federal taxes alone. But if you contribute 10% of your income to your 401(k), you’d only be taxed $2,075. This means that you save $420 on your taxes.
If you’re a visual learner, feel free to take a look at the Pre-Tax Savings Calculator below.
If you’d like to tinker around with your own income and 401(k) contributions, check out this free Pre-Tax Savings Calculator.
What stops people from increasing their 401(k) contribution is the fear that it’ll downgrade their current lifestyle. Just remember that the 10% contribution is a Pre-Tax contribution. This means that you pay 10% of your income to your retirement first before the government can take them away through taxes.
Free Money for Yourself
The benefits don’t end with tax advantages. There are much more powerful financial forces at play when you enroll in your employer’s retirement plan.
Depending on your employer, you can get anywhere between 2% to 4% of your income matched by your employer. It’s just like a donation matching charity. And the best part is that the “donations” all go to you.
I can’t think of any other investment programs that match you dollar for dollar. Don’t lose out on this opportunity if your employer offers a 401(k) program.
Use Your 401(k) to Retire as a Millionaire
But what really makes the 401(k) shine isn’t even the tax benefits or the matching contributions. A 401(k) isn’t just a typical bank savings account that collects low-interest rates. It’s an investment portfolio that grows until you withdraw from the account.
A typical 401(k) portfolio consists of mutual funds. This means that they are a combination of stocks and bonds with low risks and consistent growth. Usually, they grow at an average of 8% per year.
8% growth might not sound like much, but if you compound that over 40 years, 401(k) account will snowball into millions of dollars.
Let’s take a step back to our $35,000 salary example.
Assuming that you began your career at age 25 and you only made $35,000 per year for 40 years straight. And your 401(k) account had an annual rate of return of 8%.
You would retire with $1,250,919.
You heard right. Over $1 million just from putting away $3,500 a year into your 401(k).
Don’t believe me? Take a look at the calculations below:
As you can see, there’s more explosive growth the closer you get to your retirement. That’s the power of compounding returns. If you want to run the numbers yourself with your own salary, feel free to check out this free 401(k) calculator.
Talk to Your Payroll Officer
Now that you have the formula to retire as a millionaire, it’s time for you to set up your 401(k). It should be as easy as logging onto your 401(k) account and changing your contribution percentage.
Most employers send you a package filled with information about your 401(k). Take a look at it to find out what their policy is on matching contributions.
If you lost your 401(k) information package, or still don’t understand the benefits, you should set up a meeting with your company’s payroll. Write down your questions and go prepared.
Once you figure out what your 401(k) offers, you should try playing around with the free 401(k) calculator I used in my previous examples.
You should only contribute amounts of your salary that makes sense to you and your retirement goals. The calculator should help you determine what it would take to achieve them.
Set Up Your 401(k) for Success
I recommend starting small and then increasing the contribution amount each year. But if you’re like me and would rather set it up and forget it, 10% is a safe number to start with. Especially since you can retire with over $1 million on a $35,000 salary.
I know this might seem like a lot of work for no immediate benefit, but it’s a lot easier than you think. And the rewards are astronomical for your future. With a little bit of goal setting and planning, you should be able to set up your 401(k) for success within a few minutes.
If this topic of retiring with millions fascinates you, then I recommend checking out books like “The Automatic Millionaire” by David Bach and “Total Money Makeover” by Dave Ramsey. These authors have dedicated their lives to helping millions of Americans retire comfortably and they can help you too.
So get out there and secure your future now. Set up your 401(k) so that you’ll never have to worry about having enough money for retirement.