401(k) Plans: The Truth

If I'm going to talk about 401(k) plans, it's only fair that I share my story with you.  My first full time job was as a tax associate in a public accounting firm.  My starting salary was $32,000.  (I think.  My memory from those days is a little fuzzy.)  For the first year of my employment, the maximum amount I could contribute to my 401(k) was $9,500.  That would have been a big chunk of my salary so I did what most in their twenties do - I contributed a nominal amount to my 401(k) each pay period.  I can't remember the exact amount but if I were to guess $50, that probably wouldn't be too far off.

At that age, one sees a lifetime of work ahead and plenty of time to save for retirement.  However, I wasn't spending money on expensive shoes and bags.  I was saving to buy a house.  When I left that job five years later, I had accumulated only $10,000 in my 401(k).  My next job was with a financial institution.  The woman, who hired me, was also somewhat of a mentor.  We had worked together before in public accounting.  She told me straight up that I needed to max out my 401(k) contributions.  No excuses.  So I did and that was probably one of the best pieces of advice I've ever received.

When I left that company three years later, my 401(k) balance was six figures.

In the middle of 2017, the average 401(k) account balance was $98,000.  I recently came across an online discussion of retirement savings and some were curious as to how those with account balances in excess of $500,000 had come to accumulate that much wealth.  I'm here to tell you how that's possible.

How can I accumulate as much wealth as possible in my 401(k)?

1.  Max out your annual contributions.

For 2018, the maximum you can contribute to your 401(k) plan is $18,500.  (Those older than 49 can make additional catch-up contributions of $6,000.)  If you break this down, it's $1,541 per month or $711 every other week.  Don't forget that these are pre-tax amounts.  The money is taken from your pay before tax.

If you are unable to contribute the maximum allowed, contribute as much as possible.

2.  Take full advantage of your employer's match.

Does your employer match your contributions?  If yes, do you understand exactly how it works?  When I began working for my most recent employer, I knew there was a match and I was contributing the maximum amount allowed so I thought I was good.  My boss at the time was reading through the employee match detail (for work, not personal) and discovered that he was losing out on some of his match.  He showed it to me and I realized that I was missing out as well.  I had my account set up to pull a certain percentage of each paycheck.  I received my bonus in December and because that was a large paycheck, my 401(k) contributions would max out with it.  The fine print that we both missed or hadn't paid attention to was that the match was up to a certain percentage and the amount pulled from our bonus paychecks was over that amount.

After a few calculations, I was able to change the amount going from my paycheck to my 401(k) so that I was able to take advantage of the full match.  If you are unsure of the details of your employer's match program, ask HR.

3.  Don't take loans from your 401(k).

I realize this is somewhat of a heated topic.  Some believe that if they have to take out a loan, isn't it better to borrow from themselves?  Yes and no.  What is the loan for?  I have several friends and family members who have borrowed against their 401(k) plans and I honestly feel like all the nitty gritty details were not laid out to them beforehand because each and every one of them said to me, "It's a good deal.  I pay the interest back to myself."  And these were not hardship loans either.

So let's give an example with numbers.  Suppose you take a loan for $10,000 against your 401(k) and during Year 1 of the loan, the market is good and your overall 401(k) sees an increase of 12%.  Well, you just lost out on $1,200 ($10,000 x 12%).  Unfortunately, this loss carries forward because now you don't have that $1,200 earning income in the future.  (Note that this would be offset by earnings on loan paybacks and interest.  In other words, as you pay back your loan and interest amounts, those will increase your account and earn income but that overall loss of income will carry forward to future years.)

The money that you contribute to your 401(k) is pre-tax.  It is taken from your pay before tax.  The money that you pay back is after tax.  You are losing out here as well.

And last but not least, what happens if you leave your job?  What if another company buys out your employer and your entire group receives pink slips?  Would you be able to pay back your loan in 60 days?  If you don't pay it back, it becomes a distribution from your 401(k) subject to tax and a penalty.

4.  Work for a financial institution or company with excellent retirement benefits.

Now, I know this isn't possible for everyone.  I've worked as a tax professional for four different companies, two of which were financial institutions.  My 401(k) balance skyrocketed when I worked for the financial institutions because of the extraordinary retirement benefits.  Not only did my employer match my 401(k) contributions but at the end of the year, they made a contribution to my 401(k) based on a percentage of my salary.  Imagine, if at the end of the year, your employer plopped 10% of base salary + bonus into your 401(k).  That's huge!

A potential employer may not offer you the salary or vacation days you want but what does the entire benefits package looks like?  Don't turn down Company A because Company B is offering a base salary $2,000 higher.  Look at the big picture!