The government has blessed us with the ability to max out our 401k to $19,000 a year in 2019, up from $18,500 in 2018. If you are 50 or older, you can add up to $6,000 extra per year from $5,500.
I always recommend trying to max out your 401k as fast as you can. Once you get into a max habit you’ll rack up some big bucks in no time.
So many people don’t even bother to try because they don’t feel like it’s possible. But once they try, they kick themselves for wondering why they didn’t max out their 401k sooner. Remember, the contribution to your 401k is pre-tax so an $18,500 contribution is more like $13,800 less from your paycheck a year if we use a 25% effective tax rate.
Below is a simple chart to see how much you can accumulate in your 401k by age or years worked if you contribute $18,000 a year starting today. The chart is obviously more helpful for younger folks, given older folks had lower maximum contribution limits in the past. For example, when I first started maxing out my 401k in 2000, the contribution limit was only $10,500.
I’ve also included my high-end 401k target amount by age based off continued maximum contributions plus a constant 4-8% annual return. My high-end 401k savings target can also be considered your overall total savings target, which includes after tax savings as well. The numbers are for “ideal” conditions. We all know that life, recessions, and buying things we don’t need get in the way of savings and returns all the time.
WHAT YOU COULD HAVE IN YOUR 401K IF YOU MAX IT OUT GOING FORWARD
Having $722,000 at least by age 60 doesn’t sound too shabby to me. The numbers don’t take into account any positive returns or employer match either. Given the stock market has provided a historical 6-8% annual return, everyone who maxes out their 401k every year could have well over $1 million by the traditional retirement age if you look at my column on the right.
Unfortunately, in 38 years it will probably take $6 million or more to replicate the wealth of $1 million dollars today! Good thing the maximum 401k contribution levels will probably continue to go up every two or three years. We could be looking at a $50,000 annual max contribution limit by the year 2044.
You’ll notice that starting at 35-40 years old, my high-end total savings target really starts to rocket higher because you’ve been able to amass a nice financial nut.
For example, a 8% return on a $400,000 portfolio = $32,000. If you add on a $18,000 contribution, you’ve just increased your 401K by $50,000! Market returns start providing the large majority of the gains, which is why you should really focus on asset allocation to protect yourself from downturns.
TIPS FOR MAXIMIZING YOUR 401k
1) Remind yourself a 401k is only one leg of the retirement stool that is already broken. The other two legs of the retirement stool are a pension and Social Security. According to the Bureau of Labor Statistics about 22% of full-time private industry workers have a defined pension benefit compared to 42% in 1990. Although most public sector employees still get pensions, public sector employees account for only around 10% of the population. In other words, most people don’t have pensions anymore.
As for Social Security, the realistic calculation is that we will still all receive Social Security checks in our mid-60s, but at 70% of what is promised if nothing is done. Given most people don’t have pensions and Social Security won’t be paid in full, the 401k is the baseline defense for retirement. Thus, we must build upon our after-tax investments and alternative income streams to develop financial buffers for maximum financial security.
2) Calculate a budget based on a $18,000 reduced gross income. Nobody really sits down and writes out their expenses. We’re either afraid or lazy for some reason, yet we can spend hours doing research on our next big screen TV or laptop. But for your own sake, take your current income, subtract $18,000, and multiply it by one minus your effective tax rate to calculate your disposable income e.g. $100,000 – $18,000 = $82,000 X (1-25%) = $61,500 after taxes and 401k max.
Divide the annual income by 12 to get a monthly disposable income figure and work your budget from there. The bigger the buffer you can have from spending all your disposable income, the better. Making your contributions automatic will make savings so much easier.
3) Envision your 65 year old self greeting customers at Walmart. The biggest inspiration I get for saving and paying down debt is when I see senior citizens working minimum wage jobs. I admire them dearly for working, and I’m also scared straight into saving more because I don’t want to be them someday.
I want to be relaxing on a beach with a Mai Tai or eating an eggs Benedict with a mimosa on my private cruise ship balcony in the Mediterranean. The more we can envision ourselves in poverty, the more motivated we’ll be to, at the very least, max out our 401k.
Once you start contributing like a champ to your 401k, run your 401k through a free 401k fee analyzer to see how much in fees you are paying. I discovered I was paying a whopping $1,700 in annual 401k fees I had no idea I was paying! I quickly sold out of a couple actively managed mutual funds that weren’t performing great and into some low-cost alternatives. Remember, the more you have, the more they will want to make off you. Now I’m only paying about $600 a year in fees on a ~$400,000 portfolio.
Recommendation For Building Your Wealth
Manage Your Finances In One Place: One of the best way to become financially independent and protect yourself is to get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts in one place so you can see where you can optimize your money. Before Personal Capital, I had to log into eight different systems to track 25+ difference accounts (brokerage, multiple banks, 401K, etc) to manage my finances on an Excel spreadsheet. Now, I can just log into Personal Capital to see how all my accounts are doing, including my net worth. I can also see how much I’m spending and saving every month through their cash flow tool.
The best feature is their free 401k Fee Analyzer, which runs your investment portfolio(s) through its software in a click of a button to see what you are paying. I found out I was paying $1,748 a year in portfolio fees I had no idea I was hemorrhaging! There is no better financial tool online that has helped me more to achieve financial freedom. It only takes a minute to sign up.
Updated for 2020 and beyond.