401(k)s are amazing things. As investment accounts, they are about as good as it gets. They make it super easy to save for retirement, reduce your taxable income and set you up, hopefully, for many years of workless bliss. Let's learn how to optimize your 401(k) for greater returns. With greater returns, you can then retire richer!
However, they include restrictions. And fees that eat away at our money, meticulously over time that could add up to a surprising amount if we aren't careful.
In some ways, the 401(k) is one of the most woefully light retirement instruments ever invented. The maximum amount you can contribute is $19,500 for 2021. The amount will keep going up about $500 every couple of years.
Meanwhile, you have to make less than ~$130,000 a year as a single or less than ~$200,000 $as a married couple for the privilege of contributing the maximum $6,000 in after-tax dollars to a Roth IRA, which I do not recommend before maxing out your 401(k).
Still, the 401(k) remains one of the best and easiest ways to build wealth and invest for your retirement because, over time, compound interest builds wealth through healthy and consistent investment habits.
How can retirement investors optimize their 401(k) retirement accounts to squeeze out the very most of what they offer?
Optimize Your 401(k) Using Three Easy Steps
1) Reduce your 401(k) fees
Do you know how much in mutual fund fees you are paying a year? If you're like many people, you probably don't.
I didn’t, so I ran my 401(k) portfolio through Personal Capital’s free 401(k) fee analyzer and I’m absolutely shocked by the results! I always figured that from a percentage point of view, my mutual fund fees were small. 401(k)
But, when you take a small percentage multiplied by a big enough number, the absolute dollar amount starts adding up.
As you can see in the picture above, I’m paying $1,748.34 a year in fees across four mutual funds. In 20 years, I will have paid roughly $84,000 in fees based on only this amount.
The second portion of the above chart shines a light on the specific fund that costs the most. In my case, it is the Fidelity Blue Chip Growth Fund with a 0.74% expense ratio.
Over time, fees eat away at your net worth.
In my case, Personal Capital helped me realize that I am paying at least $1,700 more a year in mutual fund fees than I should be paying thanks to the Fidelity
How can investors reduce their 401(k) fees? Consider these 5 steps:
1) Spend one minute to sign up with Personal Capital. It’s free and secure.
2) Click the “+” button on the top left to add/link an account. For my Fidelity hosted 401(k), I typed in the search box “401k.com” since the Fidelity pre-populated button just linked to my Fidelity rollover IRA.
3) After your 401(k) account is linked, click the “Investing” tab on the top right then choose “401(k) Fee Analyzer”
4) Adjust your contributions, estimated returns, employer match, and estimated future fees to get an idea of how much you could have in your investment portfolio over time.
5) Research alternative ETFs and index funds that can replace your expensive actively managed funds. Figuring out the proper equity exposure is the most important part of your retirement planning. I encourage you not to waste time trying to pick stocks or trade in and out of sector ETFs. Instead, focus your on things you can better control or enjoy.
2) Invest as much as you can, especially if you have access to a strong benefits package
For 2019, the new 401(k) maximum employee contribution rises to $19,000, up $500 from 2018. Meanwhile, the maximum employer contribution limit also rises by $500 to $37,000, for a total 401(k) contribution limit of $56,000. Below are the details from the IRS.
If you work for a stable and profitable employer with a strong benefits program, do yourself a favor and use it. Use the heck out of it.
401(k) matching or profit sharing can significantly boost your retirement funds over time compared to working for a sexy startup that might not even have a 401(k) plan due to a lack of profitability.
For example, when I left my day job in 2012, I forewent roughly $20,000 a year in profit sharing. But at least I got them to pay for my MBA and give me a severance.
Now, I contribute as much as possible to a Solo 401(k), SEP IRA, and 529 plan.
Unfortunately, most people don't contribute everything that they could. Very few, in fact, max out their 401(k)s based on the contribution limits provided above.
The reality is that the median 401(k) account balance in the U.S. is only around $72,000 for 55-64-year-olds in 2018 according to Vanguard, one of the largest 401(k) managers.
The average 401(k) balance for 55-64-year-olds is roughly $178,000. But the average is screwed up due to the super wealthy. Even with $178,000 in your 401(k) at retirement age, you aren’t going to be living it up for the next 20 – 30 years without alternative sources of income.
According to data from Fidelity, here’s the average 401(k) breakdown by age in 2018:
- Ages 20 – 29: $9,900
- Ages 30 – 39: $38,400
- Ages 40 – 49: $91,000
- Ages 50 – 59: $152,700
- Ages 60 – 69: $167,700
- Ages 70 – 79: $160,200
Because the median age of Americans is 35.3 according to the US Census Bureau, the median 401(k) balance per person should be closer to $150,000 – $500,000 according to my 401(k) retirement savings guide instead of these pitifully low levels.
3) Assess your current retirement situation and make adjustments NOW
Though we are all different, there are basic recommendations that 401(k) investors should aim to hit, as milestones by your respective age.
If you’re just starting your 401(k) savings journey, you could get lucky and achieve the high-end column with consistent 8%+ annual growth and company profit sharing after 38 years. After all, the maximum 401(k) contributions will be much higher over the next 38 years than the previous 38 years.
How much should you save, based on age? There's a lower, middle and high end tiers of savers that most of us will fit into.
401(k) Savings Targets By Age
From these numbers, we can see that even after 38 years of consistent saving, you’ll only have around $1,000,000 to $5,000,000 in your 401(k) in a realistic cycle of bull and bear markets. You're a 401k millionaire by 60!
But it’s most likely that most people reading this article will follow the middle-to-low end columns as a 401(k) savings guide. The median age in America is roughly 36, and the median age of a Financial Samurai reader is closer to 38.
Where do you fit into this picture? If your retirement is low, start making changes NOW. Sneak a few more bucks out of your paycheck into your 401(k), and if your company offers matching, contribute at least that much.
Talk to your HR representative or financial advisor to start this process.
Optimize Your 401(k) And Build Wealth Through Healthy Habits
Sign up for Personal Capital, the web’s #1 free wealth management tool to get a better handle on your finances. In addition to better money oversight, run your investments through their award-winning Investment Checkup tool to see exactly how much you are paying in fees. I was paying $1,700 a year in fees I had no idea I was paying.
After you link all your accounts, use their Retirement Planning calculator that pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms. Definitely run your numbers to see how you’re doing.
I’ve been using Personal Capital since 2012 and have seen my net worth skyrocket during this time thanks to better money management.
About the Author: Sam started Financial Samurai in 2009 as a way to make sense of the financial crisis. He proceeded to spend the next 13 years after attending The College of William & Mary and UC Berkeley for b-school working at Goldman Sachs and Credit Suisse. He owns properties in San Francisco, Lake Tahoe, and Honolulu and has a total of $810,000 invested in real estate crowdfunding.
In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $220,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies and writing online to help others achieve financial freedom.