I love 401(k)s. I love 401(k)s! I love 401(k)s!! One more time in big font for emphasis:
I love 401(k)s!!!
I put my money to work in many investment vehicles including a Roth IRA and peer lending, but 401(k) contributions always come first.
A 401(k) allows you to save loads of money for the future in a tax efficient manner. If you’re lucky, your company may even match part of your contribution.
As great as 401(k)s are, they are not perfect. There are tricks to maximizing the value of your 401(k) and some pitfalls you need to know about. One of these pitfalls almost cost me $500,000.
However, if used correctly and given enough time, a 401(k) has a good chance of turning you into a millionaire. And who doesn’t want to be a millionaire?If used correctly and given enough time, a 401k has a good chance of turning you into a millionaire. Click To Tweet
401K Tips & Advice To Build Your Million Dollar Stash
1. Get the full match
If you were walking down the street and saw a hundred dollar bill lying there on the sidewalk, would you pick it up?
Of course you would! Leaving it there would be painful.
However, many folks leave thousands of dollars behind by not contributing enough to get the full match from their employer.
If your company offers a match, contribute at least enough to get the full amount. I will not take ‘No’ for an answer on this one. If you’re not getting your full match, you’re turning down free money. Take it!
2. Be aware of the fees
Over the long term, fees can eat at your returns like a gang of hungry Komodo Dragons. I had always read about fees, but dismissed them: “A little percentage difference won’t hurt me!” I thought to myself.
I was wrong. Very wrong.
A couple years ago, I signed up for a free service called Personal Capital that helps track your investments. One of the fabulous features of Personal Capital is its Fee Analyzer.
When I first ran the Fee Analyzer against my own portfolio, I nearly fell out of my chair. It told me that I’d pay $594,993 in fees over the next 26 years:
I moved my investments around and reduced my potential fees to less than $100,000:
Remember that pain you felt about not picking up that $100 from the sidewalk?
Imagine how I would have felt if I learned that I paid an extra $500,000 in fees. Keep in mind those fees are only until the age 65. I plan to live a lot longer than that.
I’d highly recommend signing up for a FREE account at Personal Capital to take advantage of their 401k analyzer. It might just save you $500,000 dollars (or more).
If you take action on just one piece of 401k advice after reading this article, this is the one.
If you’d like to learn more, the father of the low-fee index fund, Jack Bogle, wrote a great book on investing and fees called the The Little Book of Common Sense Investing.
3. Evaluate your 401(k) investments annually
Most companies change their 401(k) investment options regularly. It’s worth revisiting your investments every year to make sure that your employer hasn’t added better choices.
Also make sure that your investment mix is aligned with your goals. For example, if you’re approaching retirement, you should consider moving money to more conservative options.
What I did: When I saw the results of the Fee Analyzer, the first thing I did was log into my 401(k)’s dashboard to see what I was invested in.
I learned that one of the funds I had significant money in was taking 2% per year, a very high fee relative to the average. Arrrrgh! The option that I moved it to had a fee of about .7%, not nearly as low as some index funds, but a significant improvement.
4. Consider a rollover
Once you leave your job, if you have at least $5,000 in your 401(k) account, you may leave the money there. However, this isn’t always the best idea. If your choices consist of poor funds or your ex-employer charges maintenance fees, you’ll be able to do better with an account at a provider like Vanguard.
The process isn’t difficult. I’ve rolled 401(k)s over many times and the company you’re rolling into will guide you through the process.
Tip: You must make sure that the check from your old 401(k) is not made out to you. It must be made out to the company you’re rolling it over to. Again, don’t let this worry you as your new account holder will guide you through the process.
What I did: To further reduce my fees, the day I quit my job with the costly funds, I started the rollover process. Within two weeks, I had everything moved into sweet, low fee index funds.
5. Poor investment choices are not an excuse
I’ve heard people say that they don’t contribute to their 401(k) because the fund choices are poor. While this may be true, contributing to a 401(k) is almost always worth it for the tax savings alone. Every dollar you contribute is a dollar you don’t have to pay income tax on.
Remember, Uncle Sam invented this! Uncle Sam wants you to save!
Here is a simple example with a 401(k) saver named Jeff where I’ll assume the following:
- Jeff is a single guy making an average of $80,000 per year over the course of 10 years, putting his highest income in the 25% tax bracket
- Jeff contributes an average of $18,000 every year to his 401(k) for a total of $180,000
In 10 years, Jeff has saved $45,000 in taxes (25% of $180,000). Incredible! Jeff just took $45,000 out of Uncle Sam’s pocket and put it into his own.
Keep in mind that you do have to pay taxes when you eventually cash out your 401(k), but you’ll probably be in a lower tax bracket. In the meantime, all of that money is growing tax free.
6. A 401(k) works for Early Retirement
I’ve heard folks make the excuse that they don’t contribute to their 401(k) because they plan to retire before age 59.5.
I have great news for potential early retirees; there are perfectly legal and penalty free ways to access your 401(k) while you’re young. A Roth Conversion Ladder is one great way to accomplish this.
To execute a Roth Conversion Ladder, you transfer a portion of your funds to a Roth IRA. While you may pay taxes on the conversion, this money will be available to you in 5 years. This takes some planning, but isn’t difficult and is a great option for the early retiree.
7. Don’t fear stock market corrections
Way back in 2009 in the midst of the Great Recession, a friend told me that he moved his entire 401(k) balance to bonds. He went on to explain that he couldn’t stand losing money.
I asked him about his strategy recently and he told me that it’s all still in bonds, despite the fact that he’s in his 30s and doesn’t plan to retire for decades. This has not worked out well for him:
Never forget that markets are cyclical. Downturns are natural and just a part of how economies and the markets work. Stay the course.
8. A solo 401(k) is an incredible option for the entrepreneur and self-employed
Due to a change in my job in late 2014, I had to move from a W2 consultant relationship to one where I worked under an LLC. Some refer to this as “Corp-to-Corp.” I was annoyed, but then I learned about the incredible power of a Solo 401(k).
A solo 401(k) is an investment available to folks who run their own business. Similar to a regular 401(k), you can contribute $19,500 per year (as of 2020). Your corporation can also match your wages by 25%.
Since my wife is a freelancer, she was able contribute her own $19,500 to our solo 401(k). Between our $39,000 in contributions and the corporation’s match, we saved over $54,750 (!) in pre-tax money:
9. Let your 401(k) make you a millionaire
Stay with me while I show you some simple numbers and I’ll demonstrate how easy it is for a 401(k) to make you rich. I promise, the math won’t be hard.
In my example, I’m going to make the following assumptions about our 401(k) saver, Jill:
- Jill is 25 and and is starting with nothing
- She will contribute $15,000 into her 401(k) every year for 10 years
- Her company also matches with $3,000 annually
- After 10 years, Jill gets lazy and never contributes another dime
- Jill’s investments earn an average of 7%
In just 30 years, at the age of 55, Jill is a millionaire.
In 40 years, Jill is a multi-millionaire.
401(k)! 401(k)!! 401(k)!!!
Shout it with me, one more time:
Felt good, right?
If you can’t tell, I’m more than a little excited about 401(k)s. My wife and I are both 42 and didn’t max out our 401(k)s every year.
Despite that mistake, our accounts are worth about $600,000. With a couple more years of contributions, our 401(k) balances have a good chance of eclipsing the million dollar mark before we turn 50. Retirement is going to be sweet.
I encourage you to do even better than I have. Start contributing right now if you aren’t already. Watch those fees with a FREE account at Personal Capital and perhaps most importantly, stay the course when the markets take a breather.
Embrace your 401(k) and it will take you places; like an exotic beach somewhere in paradise where you won’t have a care in the world.
First drink is on me.
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