Source: 401kcalculator.org via flickr
If you've been contributing to a 401(k) for your entire career, it can be an encouraging sign to watch your account balance grow over time. However, even when you factor in Social Security, the amount you have in your 401(k) by the time you're ready to retire might not be quite enough to provide the life you want in retirement. Here's how to tell whether or not you'll have enough, and what to do about it if the answer is "no."
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How much will you have, and why it may not be enoughMost retirement plans have some type of "retirement forecaster" that projects how much money you could end up with based on your current account balance and rate of contributions. However, if yours doesn't have one (or you can't find it), here is a useful calculator you can use to estimate how much you'll end up with.
Now, determining what you'll need for retirement is another matter. Many experts use the "4% rule" which says that if you withdraw 4% of your retirement savings during your first retired year, and give yourself cost-of-living increases in subsequent years, your retirement savings has an excellent chance of lasting the rest of your life. This rule isn't perfect by any means, but it is a decent starting point for coming up with a goal.
So, if you can determine how much income you want during retirement (experts generally say that 80% of your pre-retirement income should be sufficient to maintain your lifestyle), there is a pretty easy way to estimate your needs. Simply take your desired income and subtract your estimated Social Security income. Then, multiply this amount by 25. This is how much you'll need in order for a 4% withdrawal to cover your income needs.
If your 401(k) isn't projected to reach this amount, you may need to change your strategy a bit. There are two main ways you can do this.
Solution 1: Increase your 401(k) contributionsThe majority of 401(k) participants contribute exactly enough to take full advantage of their employer's matching program. If the employer is willing to match 4% of their salary, that is what they contribute -- no more, no less.
However, you may be allowed to contribute a lot more than your employer's matching maximum. For the 2015 tax year, the IRS allows up to $18,000 in elective deferrals (which don't include your employer's contributions), and if you're over 50 you can choose to have up to $24,000 of your salary deposited into your 401(k).
A little difference in contributions can make a big difference. Consider a worker who starts a job at 30 earning $50,000 per year and whose employer is willing to match up to 4% of the salary. By contributing even an extra 1%-2% of their salary, it could make a big difference over the long run.
Note: Assumes 7% average annual investment gains and 2% annual salary increases
This is a perfectly good option for people who prefer to take a more passive role in their retirement. By simply having more money deducted from your paycheck, the investment funds in your 401(k) do the work for you. And, be honest -- will you really miss that extra 1% of your salary?
Solution 2: Start investing in an IRAFor those who may need a little more retirement savings, and want to take a more active role in their retirement, an IRA could be the best choice for you.
When it comes to IRA, there are two basic choices: traditional and Roth. A traditional IRA works similarly to a 401(k) in the sense that your contributions may be tax-deductible (depending on your income and eligibility to contribute to an employer's retirement plan). A Roth IRA doesn't allow for contributions to be deducted, but any qualified withdrawals once you retire are tax-free.
With both account types, your investments are allowed to grow and compound without having to pay capital gains or dividend taxes each year. And, both account types allow for up to $5,500 in annual contributions ($6,500 in over 50).
In an IRA, you are free to invest in any stock, bond, or mutual fund you choose. For advice on how to choose good retirement stocks, check out this article.
Other possibilitiesThis highlights just two of the options you have to boost your retirement savings. There are other potential ways to make sure you don't run out of money in retirement, such as
- Work a few years longer-- Not only does this give you extra time to let your savings grow, but you'll also get a nice Social Security boost if you wait a few extra years
- Get out of debt before you retire-- If you make paying down your debts a priority now, your income requirements once you retire could drop significantly
These are just a couple of examples, and there are literally hundreds of other things you can do to boost your retirement income or trim expenses, but the same general themes apply. Save as much as you can, live within your means, and use the tax-advantaged savings options at your disposal.
The article Will Your 401(k) Be Enough For Your Retirement? originally appeared on Fool.com.
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