Advice to invest in your 401K is everywhere, as it should be, it is one of the best retirement vehicles available in the United States. Today I am going to show you some proof that if you start with small investments and iterate as your income grows, your 401K balance will explode over time. I am not mocking the numbers, below you will see a quarter by quarter breakdown of my 401K balance, directly from my statements.
Before diving into all things 401K, I want to note that we also use a Roth IRA. I think there is value in spreading money across both tax vehicles. Roth IRAs are also a good solution for financial windfalls outside of your 9-5 paycheck.
Proof you need to start investing in your 401K
The next few sections show 5.5 years of 401k contributions, employer matches, growth (or loss) and the total portfolio balance broken down by quarter. Graph and number nerds, enjoy!
It’s like stealing money from yourself but for future you
I have mentioned this before, but when I first started my career we were saving next to nothing. Looking at the below graph, I was saving well under $500 a quarter for the first 1.75 years. By the end of 2016, I was saving about $2,000 a quarter.
Methods used to increase 401K Contribution
- Set yearly goals to increase my withholding % each quarter in 2015 and 2016
- As my income rose, I increased the automatic contribution so my take-home pay didn’t change
My goal is to eventually max out my 401K contribution by increasing the allocation everytime my income increases. This year I am on track to contribute $12,800. I remember reading Financial Samurai’s The Average 401k Balance And Why It’s Too Low post about 3 years ago and thinking it was impossible for me to put $18,000 away every year.
It’s not impossible, he is right, anyone can do it if they make it a priority.
The dips from previous quarters are caused by a variation in the number of paychecks. I have not reduced my contributions since I started.
Remember the employer match
Gotta love free money! Our match is below the industry average. We only get a 1.5% match if we put 6% in, but that still adds up over time and makes a huge impact when compound interest is factored in. The good part is the match increases with your salary, extra savings every time you get a raise. AUTOMATICALLY.
For those of you who have a better match, I am jealous. For those of you who have a better employer match and aren’t taking advantage of it, get with the program!
I was not eligible for the employer match my first year of employment. Over the last 4.5 years, my employer put over $3,800 into my account. It would have been more if I would have jumped right to 6% when I became eligible. Don’t wait!
There will be ups and downs
Not much to say here except for I have been riding a 5.5-year bull market since I started investing. There was only 1 ugly quarter that flipped pretty quickly. It was a little funny looking back at the first years 401K statements and seeing a $23 loss over the course of 3 months.
I am looking forward to bigger swings on a quarterly basis as my balance grows. Eventually, the gains will eclipse my quarterly contributions.
Hard to argue with the results
From $0 to $27,480 in 5.5 years.
While this looks like a pretty standard up and to the right graph, I want to point out a few things
- Took 9 quarters to accrue first $5,000
- The last $5,000 only took 2 quarters.
- My quarterly contribution has been enough to offset any market loss to date. I expect that to change as my balance increases but that is still a ways out.
- Employee Contribution – $20,575.47
- Employer Contribution – $3,823.51
- Total Gain – $3,021.03
- Portfolio Balance – $27,480.18
Oh, and there is the tax savings
Money put into your 401K is not taxable, so there are significant tax savings every single year you contribute. Over the last five years, I saved over $5,000 on my tax bill. Since Mrs. AE also contributes our household savings are even higher. In 2017 alone, we are expecting to save another $5,000 (assuming we contribute $20,000 combined this year).
Employer 401K matches are also not taxable, so it’s free and tax-free. Boom.
Way down the road, you will have to pay taxes when you withdraw from your 401K, but the idea is that you will be in a lower tax bracket and the growth on the tax-free money will outweigh tax costs.
For above average earners that still have student loans or contribute to a Roth IRA, you can use your 401K to reduce your income and drop below the “phase out” limits for contributing to a Roth IRA or deducting Student Loan interest on your taxes.
What can happen over 30 years
If you want to see what investing in your 401K can do over 30 years, check out this awesome post “How to become a 401K Millionaire.” There is a ton of great information from Fritz, who is rapidly approaching early retirement. He writes at The Retirement Manifesto and recently published an awesome post for people who are starting their journey a little later as well: It’s Never Too Late To Start Saving For Retirement.
If you are already a regular 401K contributor, Great! Keep working your way to the maximum limit and watch your balance grow while enjoying awesome tax benefits. If you need some motivation, try setting yearly goals. Increase your contribution 1% a quarter or dedicate your entire raise to your 401K every year.
If you are like me 4 years ago and aren’t investing up to your employer match, your number 1 priority should be getting the full amount. Don’t let free money slip through your fingertips.
Even if you don’t get an employer match, the tax benefits alone are worth it. Don’t sacrifice YOUR future because they aren’t matching anything.
If your significant other is also investing in their 401K, you could be a double 401K Millionaire. Think of the possibilities…..