It's not a secret that most Americans are behind on retirement savings. And that's a problem, because the typical retiree needs more than just Social Security to stay afloat financially.
But a recent study by Bank of America Merrill Lynch reveals a bit of good news: It seems 401(k) participation rates are on the rise. Specifically, last year saw a 6% increase in new 401(k) plan enrollments, and a 20% increase in contributions.
Just as importantly, 401(k) participation increased among all age groups. Of those eligible for a 401(k), 82% of workers aged 21 to 34 made contributions, as did 77% of workers aged 35 to 49 and 75% of workers aged 50 to 68.
Given the need for retirement savings, the fact that more people are getting wise to the importance of building a nest egg is an extremely positive trend. On the other hand, let's not overlook the fact that a good 18% of younger workers, 23% of thirty- and fortysomething workers, and 25% of older workers aren't taking advantage of their employers' retirement plans despite being eligible. And that's a mistake that could cost them big time.
The benefits of 401(k)s
Though IRAs offer their fair share of benefits as well, 401(k)s have their own distinct advantages -- namely, the fact that participation is virtually seamless. All you need to do to contribute to a 401(k) is tell your employer how much to deduct from your paycheck each month, and voila -- your account is consistently funded. Want to increase your contribution rate? It's usually a simple matter of filling out a form or changing your election online.
Another benefit to saving in a 401(k) is that you get the option to sock away much more cash than you would with an IRA. Currently, IRA savers under 50 can contribute up to $5,500 per year, while those 50 and older can contribute up to $6,500 annually. But with a 401(k), you get to put up to $18,000 a year away if you're under 50, and $24,000 a year if you're 50 or over. And that's huge, because if you manage to max out your 401(k) for the bulk of your career, you stand to retire a millionaire many times over.
Here's how the numbers shake out. Say you contribute $18,000 a year to your 401(k) for 35 years -- technically, you'd eventually reach the point where you'd be able to increase that contribution to $24,000, but for our example, we'll keep things simple. If your plan investments generate an average annual 7% return, which is more than doable with a stock-heavy portfolio, you'll wind up with nearly $2.5 million by the time you're ready to retire. Increase your savings window to 40 years, and you'll be looking at a cool $3.6 million.
Of course, not everyone has the ability to max out a 401(k), but even if you only manage to put away a few hundred dollars a month, if you start early enough, you can still retire a millionaire. The following table shows much you stand to accumulate if you start contributing $500 a month to your 401(k) at various ages:
The more time you give your money to grow, the more you'll get to take advantage of compounding and boost your nest egg. Saving just $6,000 a year consistently over a 40-year period, for a total of $240,000 in out-of-pocket contributions, will leave you with well over $1 million by time retirement comes along. Even if you don't manage to start saving until age 30 (say you're working on paying off student debt and aren't earning as much), as long as you set aside $500 a month consistently from that point forward, you'll come away with a pretty respectable $829,000 nest egg.
On the other hand, the longer you wait to start funding that 401(k), the less you stand to gain in the long run. So if you're lucky enough to have access to a 401(k), be sure to contribute something starting now, and aim to ramp up your savings rate over time. Your retirement truly depends on it.
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