How To Set Up Your Million Dollar 401(k) Plan At Work
Updated: Jun 22, 2021
Many workers do not realize that they can retire with over $1 million dollars in their employer's retirement account. Most of you are in one of the following categories: 1) just starting a new job, 2) working and have been at your current gig for a number of years, or 3) your job doesn't offer a 401(k), 403(b), or 457 plan. Those of you who are in category #3, we'll have a special article for people who do not have an employer plan at work. For the purpose of this article, we will be just covering categories #1 and #2 only.
How To Set Up Your 401(k) Plan
Setting up your 401(k) at work could be one of the biggest decisions you'll ever make in life. It is extremely important because many of you may not yet take in consideration that the sooner you began contributing to your employer's plan, the more you will have at the end of your working days.
Let's take Gary for an example: if Gary worked for his employer and contributed at least $500 every month, with a projected 10% return for 30 years, he'll end up with approximately $1,090,895 at the end when he hangs it up. Go to calculator.net to figure out your own projections.
In Gary's case, he decided he could comfortably contribute $500 each month. You may be able to contribute more or less - depending upon how much you can afford. Can I give you my suggestion? I would recommend that you invest at least 8% into your 401(k) and increase that figure 1% each month until you reach 15%. Here's an example: If you're pulling down $45,000 annually at work, 8% of your annual salary would be 3,600. That's $300 per month. Not bad! It may sound like a lot but you're basically paying your self first before the government takes its share of your hard labor in which will leave you with a stock pile of money at the end.
401(k) plans typically offer a list of investment options for employees to choose from. The options you can choose from depend on your employer and the 401(k) administrator they choose, usually a major mutual fund firm that offers 401(k) management as an additional service.
Your 401(k) investment options are made up of mutual funds. Mutual funds allow you to buy a group of stocks and bonds all at once rather than investing in individual stocks. This gives you a diverse portfolio instantly, which is a huge benefit.
In some cases, the best option is to put everything into a target date fund. This type of fund, also called a target retirement fund, is a “fund of funds” managed to include the best investments for someone your age. If you don’t have this option, you can choose between the other funds your employer offers. Here are some popular types of funds you may have the option to choose from:
Broad market fund – Funds that include all stocks in an index like the S&P 500, Dow Jones Industrial Average, Russell 2000, or other major groups of stocks are a great option. In fact, Berkshire Hathaway CEO Warren Buffett, one of the most successful investors of our time, suggests the average investor put 90% of their investments into a low-cost S&P 500 index fund and 10% in a short-term government bond fund. That is not a bad plan to follow if your 401(k) allows and could lead to the best investment return.
Domestic Stocks – Many mutual funds are focused on a sector of the stock market, like large companies, small growth companies, or a mix. These are United States based, and are generally considered more predictable and safe than foreign stocks.
International Stocks – International stocks may fall under the same categories as domestic, but with a few more options to focus on a specific country. Funds like an international growth fund may be more risky investment options.
Bond funds – Bond funds invest in United States government, municipal, and corporate bonds. Bonds are a form of debt that are paid back over time. Bonds are generally safer investments, but offer a lower return.
When choosing your investments, pay attention to the fees. In addition to a 401(k) account management fee, you have to pay fees charged by each mutual fund. If you see two similar investments with different fees, make sure to choose the cheaper one. Fees can eat up months or years of retirement savings, so it is important to understand the costs of each investment you choose.
Setup Automatic Increases
Some 401(k) providers give you the ability to automatically increase your percentage contribution on a periodic basis. When I had a full-time day job, I always set this increase to take place annually at the beginning of the year, just before annual reviews and raises took place.
Increasing your 401(k) contribution at the time you get a raise is a great idea for a couple of reasons. First, it helps you save more for retirement. Personal finance experts generally suggest saving at least 10% of your annual income to maintain the same quality of living in retirement, and just taking advantage of the employer match won’t get you there in most cases.
Second, automatic increases help you avoid lifestyle inflation. As you earn more, it is easy to get into a habit of spending more. But you are already used to living without that money, so putting it away for retirement before it ever touches your checking account will guarantee it goes to your future rather than a silly purchase today. If you automatically increase your 401(k) savings, your future self will thank you.
At some companies, you can’t keep all of your employer contributions if you decide to leave the company unless you have worked there for a minimum length of time. This is called vesting. Some employers give you 100% vesting once you reach a specific anniversary with the company, while others give you a percentage each year until you reach 100% at a specific date.
You keep all of your contributions no matter how long you worked there, but your employer match may be contingent on reaching a specific work anniversary. The best employers give you 100% of the contribution up front, but companies use vesting as an incentive to keep employees working at the company for a longer period before jumping ship to another job.
Set and Forget
Unlike active investing in the stock market, retirement accounts should be approached with a “set it and forget it” mentality. Aside from an occasional check in and rebalance, you shouldn’t bother with your 401(k) investments. Just let your automatic contribution every payroll do its thing and you’ll be all set.
If all of this sounds confusing to you, you might consider opting for a service like our $50/50 Club Program. We will help you manage your 401k, Roth & IRA accounts, attend our FREE investing 101 classes and answer all of your other personal finance questions that you may have. It’s a great service that allows you to stay on track. Learn more here.
In Gary's case, he decided he could comfortably contribute $500 each month. You may be able to contribute more or less - depending upon how much you can afford. At my firm, we recommend our clients start out and invest at least 8% into their 401(k) plan and increase that figure 1% each month until they reach 15%. Here's an example: If you're pulling down $45,000 annually at work, 8% of your annual salary would be 3,600. That's $300 per month. Not bad! It may sound like a lot but you're basically paying your self first before the government takes its share of your hard labor in which will leave you with a stock pile of money at the end.
The worst thing you can do is ignore your 401(k) or retirement savings, which is not uncommon today. But don’t be like the average person who will struggle when they reach their golden years because they did not began early and didn't contribute enough. Instead, put in the time on your first day of work to setup your 401k to ensure you have a great future ahead. If you follow these tactics, you may just end up with a million dollar 401(k) account when its time to call it quits!