Let’s take a poll. What do you think is the factor that affects the value of your 401k the most? Pretty heavy question especially considering that most of us probably will depend on our 401ks as the main source for our retirement money.
I don’t know about you, but for me knowing what I can change now to get me more money later in my 401k sounds pretty interesting. Well let’s take a closer look at this subject shall we?
To take a closer look, we will examine our friend Bart and his 401k.
Bart works as a marketing account manager at the new up and coming firm Sur de Media. This is Bart’s second job out of college where he had a 401k available to him In his first job but decided on not contributing because he needed extra rent money at the time.
He makes $50,000 a year and just began contributing $1,500 of his salary a year to his 401k at Sur de Media. Here are a couple other assumptions we will make going forward regarding Bart’s entire 401k situation.
- $50,000 of income per year
- Contribute 3% of salary to 401k ($1,500 per year)
- Currently 27 years old
- Plan to retire when 62
- 8% Annual Rate of Return
- Pays 1.50% annually in 401k fees
- Contributions made at the end of the year
When Bart Retires at age 62 he will have accumulated approximately $199,645 in his 401k given our above assumptions, remember that number.
Not a bad little nest egg to say the least but could it have been more and if so how?
What if Bart got a higher rate of return? I’d think it would have a significant impact to increase the amount of money Bart has. How about lowering those 1.50% of fees he is paying every year? That can help increase his 401k value no doubt.
Let’s Put Numbers to It
How about this, Instead of having a vague idea of what will affect Bart’s 401k value the most, how about we dive a little deeper and look at the numbers. Keep in mind, some of these factors are somewhat out of Bart’s control (rate of return, employer match, fees) and others are completely in his control (how much he contributes to the plan, what age he how early he began contributing).
- Lowering Fees and Expenses
High fees, high fees, high fees. That is what is being hammered home as what is going to jeopardize your ability to save money and retire.
So you’ve heard that high fees have the chance to derail your retirement outcomes but to what extent. What exactly is the effect on the amount of money Bart has at retirement paying 1.50% of fees in his 401k as opposed to 1.00%? Funny you should ask.
|Bart’s 401k Balance w/ 1.50% Fee||Bart’s 401k Balance w/ 1.00% Fee||Difference|
Taking into account our baseline assumptions about Bart’s 401k account, we can see that if you lower fees from 1.50% to 1.00% Bart would have saved approximately $23,725 that could have been added to his 401k balance over the course of his working career. Yikes, that’s a lot of dough.
While fees are an important thing to take into consideration, they and they alone will not solely affect your ending 401k account balance.
- Better Investment Performance
How much does investment performance affect your 401k balance? I would think a substantial amount especially if that performance is compounded over your working career.
Let’s take a look shall we. If you bump the performance of our investments from 8% up to 9% the value of your 401k at retirement should grow, but by how much?
|Bart’s 401k Balance w/ 8.00% Annual Returns||Bart’s 401k Balance w/ 9.00% Annual Returns||Difference|
Pretty significant increase of $50,585 to say the least.
It’s important to remember that although you cannot control the markets, you are able to control how you’re invested. Making sure that you’re properly invested in your 401k could potentially make that 1% difference as shown in Bart’s example.
In turn, adding a significant amount to your 401k balance at retirement as shown above.
- Adding An Employer Match
The Employer Match; I’ve harped on this one for a while but it does make quite the difference when it comes to the amount of money you have in your 401k at retirement.
Remember that a 401k Employer Match is the amount in your 401k that your employer puts in your account to match what you have put in. This match (what I like to consider as “free money”) that your employer contributions helps incentivize you to contribute to the plan in the first place.
Let’s see how Bart’s 401k balance would change if his employer offered him a 3.00% match at the end of every year..
|Bart’s 401k Balance w/ No Employer Match||Bart’s 401k Balance w/ 3.00% Employer Match||Difference|
In the example shown above Sur de Media, Bart’s employer provided a 3% match on Bart’s contributions. In other words, they matched Bart’s contributions for every year up to 3% of Bart’s salary or in Bart’s case $1,500 a year.
This match makes a huge difference in the value of the Bart’s 401k at retirement (a $199,645 difference to be exact).
Although an employer match will significantly help your 401k account balance down the road, it’s important to remember that not every employer is able or willing to offer a match. Even if your employer doesn’t offer a match in their 401k plan don’t be discouraged, as you will see there are things that are in your control that can affect the value of your 401k.
- Increasing The Amount You Contribute
Would we all agree that what we pay in fees in our 401k, the investment performance of our 401k and whether or not our employer gives us an employer match are all aspects of our 401k that remain fairly out of our control.
It’d be nice to be able to control these outside factors but in the end most of us as employees probably can’t. So what can we control? Well good news for you is that you can control two of the most important factors that will impact the value of your 401k at retirement.
The first being how much you actually contribute to the plan.
The amount you contribute to the plan goes without saying as being on of the main drivers toward the amount of money you have in your 401k at retirement. You may think that it requires significant increases in how much you’re putting away to really make a difference in your 401k down the road. Not necessarily.
Let us keep all the assumptions we’ve been working with our friend Bart and assume that instead of contributing $1.500 a year to Bart’s 401k, how about he ups it to $2,000 a year.
This $500 a year increase may seem significant but on a monthly level Bart would only be increasing his contributions to $41.67 a month.
|Bart’s 401k Balance Contributing $1,500 Per Year||Bart’s 401k Balance Contributing $2,000 Per Year||Difference|
Increasing Bart’s contributions by $41.67 per month or $500 annually allowed his 401k value to grow by an additional $66,548 at retirement!
That’s almost double the amount of decreasing Bart’s 401k fees just through that minor monthly increase to his contributions.
- Delaying when you start contributing
Have you had a 401k available to you at your employer but haven’t got quite around to putting money in it yet? Need the funds for bills, going out to bars on the weekend or spending the money on your significant other?
I get it, there are times where it’s impossible to set aside the extra money for retirement especially when current needs are at the forefront. But if you can contribute some money earlier, the impact it will have down the road can be immense.
Look at Bart’s case, if you recall he had no money accumulated in his 401k when he was 27 because he didn’t want to save right out of college at his previous employer.
What difference could that extra 5 years of saving have made down the road if he had saved $10,000 at his old employer’s 401k? Funny you should ask…
|Bart’s 401k Balance With No Contributions Prior to 27||
If Bart had started saving right out of college and accumulated $10,000 he would made out on $96,513 of additional money once he retires at 62.
Why is this such a large figure you may ask? Simple, the power of compounding.
Having that additional $10,000 of money compounding over Bart’s working career makes a huge (more specifically an $88,623) difference when he finally retires.
Well what can we learn from Bart’s situation? Let’s take a look at the overall picture.
|Lower Fees by 0.50%||+$23,725|
|Increase Returns by 1.00%||+$50,585|
|Receive a 3% Employer Match||+$199,645|
|Contribute $500 More Per Year||+$66,548|
|Bart has $10,000 in 401k from Contributing when he was 22||+$96,513
What Bart Can’t Control
We know that there are things in Bart’s 401k that he can control and there are things that are out of his control. Fees, increasing returns and receiving an employer match are factors that are up to Bart’s employer or dependent upon how the stock market does.
Luckily for us, lowering fees by 0.50% (which is a very significant fee decrease) ranks last in adding to Bart’s overall 401k value at retirement.
This kind of goes back to the fee and expense upheaval that we’ve been hearing lately. Fees are important and do make a difference in the value of your 401k, that being said I want to emphasize that it is not the only aspect of affecting the value of your 401k.
There are other factors that are within your control that can have as large of an impact or even larger impact than fees can.
Rate of Return
Increasing annual returns by 1% over the course of Bart’s working career does add a significant amount to his account value. One thing of note here, although the performance of the market is out of Bart’s control, he is still able to make sure he is invested properly within his 401k plan to manage risk and potentially optimize his returns over his working career.
If Bart is properly invested an extra 1% annual rate of return is not out of the realm of possibility. So in actuality while market performance is out of Bart’s control, making sure he’s properly invested in his 401k to maximize his returns is well in his control.
What Bart Can Control
Good news for us and Bart, there are things that he can control now that will make significant impacts on the value of his 401k later.
How much he contributes to his 401k
As mentioned earlier if Bart simply increases his contributions by $500 a year he would have accumulated $66,548 more when retirement comes knocking. Although $500 a year seems like a lot, when we break it down into a monthly figure it’s only $41.67 a month. Seems much more manageable now doesn’t it?
Start contributing earlier
Imagine if Bart started contributing to a 401k during his first job when he was 22 right out of college and accumulated $10,000 by the time he started his job at Sur de Media at 27.
This extra $10,000 he would have accumulated may not seem like a lot but because of the wonders of compounding and Bart’s long timeframe till retirement, that $10,000 made a $96,513 difference than if he had nothing in a 401k until he was 27.
Bottom line: The earlier you start contributing to a 401k, the more you will probably have in that 401k when you retire.
As I mentioned before, it’s not simply one aspect of your 401k that will decide whether you have too little or the proper amount of money when you retire. It’s a combination of different factors.
Some of those factors are out of your control. Some of those factors you directly can affect.
The most important thing to remember is that by controlling what you can control regarding your 401k, you will increase your chances at having a sufficient amount of money in your 401k at the end of your working career.
401(k) plans are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if take prior to age 59 1/2, may be subject to a 10% federal tax penalty. Investing involves risk and investors may incur a profit or a loss. Diversification and asset allocation do not ensure a profit or protect against a loss. This case study is hypothetical and for illustrative purposes only. Individual cases will vary. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Prior to making any investment decision, you should consult with your financial advisor about your individual situation. Any opinions are those of Jacob Dahlstrum CFP, Financial Advisor and not necessarily those of Raymond James. As with all ERISA-governed retirement plans, Plan Participants should refer to the most current Plan Document and/or Summary Plan Description will indicate plan provisions and benefits, and should be consulted periodically.