Millennials: How to Become a 401(k) Millionaire

Thinking about what life will be like when you're 70 isn't an enticing activity when you're a millennial, but daydreaming about being a millionaire is exciting.

The track to a fat 401(k)

Increase contribution 1% a year.
Think of it as a tax you must pay yourself.
Contribute enough for employer match.
Don't let other goals hinder savings.

One of the most effective steps to take toward wealth is to enroll in your employer's retirement plan. Even if you can afford to save only a little money at first, the power of starting early will reap huge benefits when you retire, says Meghan Murphy, director of thought leadership at Fidelity Investments in Boston.

David Weliver, founder of the Money Under 30 website, agrees.

"The best thing you can do is to start putting away money in your 401(k) immediately so you won't miss it at all," he says.

Automate your participation

Millennials -- people ages 18 to 34 -- are better educated about money from having grown up during the financial crisis and want to take advantage of retirement programs, says Rocco Papandrea, senior vice president and wealth management adviser at Bank of America Merrill Lynch in New York City.

According to research by Bank of America Merrill Lynch, 64% more of millennials started contributing to 401(k)s in 2014 than in 2013. Research by Transamerica Center for Retirement Studies in 2014 showed that 71% of eligible millennials participate in 401(k)s or other similar plans offered by employers.

"Increased millennial participation can be attributed to employers providing automatic enrollment for all employees," Murphy says. In companies without auto-enrollment, participation by millennials in their 401(k) plans falls.

Fidelity's Murphy says enrolling in an automatic annual 1% increase in 401(k) contributions, particularly if the increase is tied to when you normally get a raise, is an easy way to gradually boost your savings without a significant dip in your paycheck.

"The idea is to get a certain amount of money into your savings before it gets into your hands," Murphy says.

Make your 401(k) a priority

In an ideal world, everyone would put as much as possible in a 401(k) plan, especially now that few jobs offer a pension and Social Security benefits are uncertain for millennials, Money Under 30's Weliver says. However, millennials have other financial priorities, such as saving for an emergency fund or a down payment on a house, or starting a family or paying off student loans.

"Plus, there's no question that it's easier to get excited about saving for a house or a baby than for your retirement 40 years in the future," Weliver says. "But look at it this way: If the government increased your taxes by 5%, you'd complain, but you'd pay it. Think of this as a tax that you have to pay to yourself that will help you in the long run."

Weliver says that in spite of competing priorities, you should contribute at least up to the amount that your employer will match. Typically, employers match 50% of your contribution up to 6% of your salary.

Weliver recommends paying off credit card debt and student loans and saving for a house while funding your retirement with the minimum contribution to get your employer's match, then increasing your contribution as those other goals are met.

Allocate savings for maximum impact

Murphy says she had a "deer in the headlights" look on her face when first faced with an investment decision, but she says enrollment support and investment options make it easier for novice savers today.

"You need to decide if you want to do it yourself or if you prefer to do it with someone else," she says. "DIY investing takes time, skill and will, so you need to make sure you have what it takes to do it well."

Those who prefer getting investment help can take advantage of 401(k) plan guidance or choose a target-date fund tied to the year you turn 65 or 67, Murphy says. Target-date funds automatically reset the asset mix of stocks, bonds and cash equivalents in a portfolio, according to a selected time frame that fits a particular investor.

Bank of America Merrill Lynch's Papandrea says these funds use a "glide path" allocation method, which is weighted toward equities and growth funds when you're young and automatically invests more conservatively when you get closer to retirement.

Murphy says about 60% of millennials are 100% invested in target-date funds in 2014, partly because a target-date fund is the default investment vehicle for employees who don't choose a specific allocation when they are automatically enrolled in a 401(k).

"When you're young, it's the perfect time to make a riskier investment," Weliver says. "Millennials are more risk-averse, but the worst thing you could do is to keep your money in cash or a money market account, earning 1% in interest."

Papandrea says millennials can use online calculators to customize their investments. Most 401(k) plans also provide an adviser to contact for guidance.

Avoiding the cash-out crash

If your goal is millionaire status, Murphy says, "never cash out your 401(k) when you change jobs. It can be tempting to get your hands on $5,000 or $10,000 when you're young, but it's a huge mistake."

Not only do you lose the long-term advantage of those savings, but you incur a 10% tax penalty for early withdrawal and pay income tax on the cash.

Putting your money away slowly and steadily for 30 or 40 years may not be the most glamorous way to become a millionaire, but it's far more common to do it that way than to win the lottery, Murphy says.