How You Can Become a 401(k) Millionaire

By Markets Fool.com

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Source: Taxcredits.net via Flickr.

If you'd like to become a millionaire, your 401(k) is likely the best tool available to you to help get you there. Thanks to key features including automatic investing, a possible employer match, tax-deferred compounding, and potentially tax-deductible contributions, your 401(k) is designed to help you amass that kind of money.

Indeed, if you start early enough, invest at a sufficient level consistently throughout your career, and follow a reasonable long-term strategy, becoming a 401(k) millionaire is remarkably straightforward. It's still not easy to keep up the pace for the decades required to get you to millionaire status, but it really is that straightforward.

When can you get there?
The two primary factors that determine when you reach that millionaire status in your 401(k) are how much you can sock away each payday and the rate of return you earn on that invested cash. In 2015, the 401(k) contribution limits are $18,000 per year for people under age 50 and $24,000 per year for those aged 50 and up.

The table below shows a range of possibilities for a typical 401(k) investor within the limit for those below age 50:

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Over the long haul, the broad U.S. stock market as measured by the S&P 500 has delivered nearly 10% annualized returns, but those returns are both volatile and come with absolutely no guarantees. Still, in the time frames it will take to reach millionaire status in your 401(k), it's worthwhile to invest in stocks to strive for those long-run potential returns, despite the short-term volatility.

As you ponder the switch from saving to spending your retirement, that volatility becomes far more important to your ultimate success. While you're building that nest egg, however, you'll likely be better served by consistently investingno matter what the market's doing. After all, if you wait for the perfect time to start investing, you risk learning firsthand the very expensive lesson that $0 invested winds up as $0 in retirement, no matter what rate of return you presume.

If you'd rather not invest completely in stocks, it's OK to include some bonds in your mix as well. Just be sure to understand that in today's low interest rate environment, a substantial bond allocation will likely lower your overall expected returns. As that table above shows, earning a lower rate of return simply means you'll have to sock away that much more for that much longer to wind up a millionaire.

You don't have to do it on your own
While it might seem like a daunting task to set aside that much money every month, you don't have to do it alone. Uncle Sam and your employer might both be willing to help you get there. In a traditional 401(k) plan, your contribution is tax deductible -- it comes out of your paycheck before federal taxes. As a result, the impact of your contribution on your take-home pay is reduced by your marginal tax rate. And if your employer offers a matching contribution as well, it's that much more working on your behalf.

While match levels differ by employer, a typical match is 50% of your contribution, up to some maximum percentage of your salary. If you're in the 25% federal tax bracket and receive a 50% match on your contribution, the combination can effectively instantly double your money. The table below shows details of how that works:

Activity

Amount

Your Contribution

$1,000

Your Employer's Match (50%)

$500

Total Contribution

$1,500

Tax Deduction (25%)

($250)

Your Out-of-Pocket Cost

$750

Table by author, based on discussion in text.

So for $750 out of your pocket each month -- about $25 per day -- you've got a great shot at becoming a 401(k) millionaire within the next two or three decades. Yes, that's real money out of your pocket that you can't spend on something else today. But with a strong chance at a $1 million or more nest egg waiting for you in your 401(k) at retirement, isn't it worth making that small sacrifice now for that incredible payoff down the road?

Now's the best time to get started
Regardless of how much you're able to put away each paycheck, the one thing that remains constant is that the sooner you get started, the sooner your money starts working for you. Get started now, and you keep the time you have left working for you. If you can't go from $0 to your ultimate savings target in one fell swoop, that's OK. It's better to start with what you can and increase your contributions as you're able than to wait and lose that time.

The article How You Can Become a 401(k) Millionaire originally appeared on Fool.com.

Chuck Saletta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.