How to become a 401(k) millionaire

The Fidelity Investment Report stated that as of the end of the fourth quarter of 2019, the number of 401(k) millionaires—investors with 401(k) account balances of US$1 million or more—reached 233,000, compared with the third quarter. The number of 200,000 people has increased by 16% and is more than 1,000% more than the 21,000 people in 2009. Joining the ranks of 401(k) millionaires is actually achievable, but you need to be consistent, patient and appropriate in your investment choices.

Key points

  • Start contributing to the 401(k) plan as early as possible.
  • Contribute regularly and at an appropriate level.
  • Get your own hands on your 401(k) investment and don’t be afraid to take risks, especially when you are young.

How to become a 401(k) millionaire

Continuous and sufficient contribution

The process of becoming a 401(k) millionaire is slow, which is no different from training for long-distance running. When you are eligible to contribute to a 401(k) plan for the first time, contribute as much as possible. If your employer provides a match, please contribute enough to get a complete match. Failure to do so is to leave free money on the table.

The key is to start early. Even if you can only afford 3% of your salary, start now. Try to increase to 4% or 5% next year and every year until you are close to the maximum contribution limit. The 2021 limit is US$19,500 (increased to US$20,500 by 2022), and an additional US$6,500 in back-up payment is provided for people 50 years or older at any time of the year.

Appropriate investment

Choose your 401(k) account investment based on your financial goals, age and risk tolerance. The general rule is that the longer the time before retirement, the greater the risk you can take. If you do not take appropriate risks, your account will not grow at the fastest rate.

There are numerous stories of plan participants in their 20s who have all or most of the accounts in the planned currency market or stable value option. Although these options have low risk, historically, they have not performed as well as stocks in the long term.

When you change jobs, don’t ignore your old employer’s 401(k), otherwise its growth may be affected.

Don’t ignore old 401(k) accounts

If you change jobs, you need to decide what to do with your old employer’s 401(k) account. You have several options: transfer the account to an individual retirement account (IRA), keep it in the old plan, or transfer it to the new employer’s plan.

How you transfer funds from an existing account to a new account will have tax implications. Since the funds deposited in a 401(k) are tax-deferred, withdrawing funds within 60 days without depositing them in a new tax-deferred retirement savings account may trigger tax payable if you are less than 59½. Instead, use direct rollover to avoid paying taxes or fines when withdrawing money.

The most important thing is to keep track of this money. As your career advances and you have more employers, it may be difficult to remember where all your assets are. Regardless of the choices you make now, you may want to merge them with other retirement accounts later to make your funds easier to manage.

Target date funds are not a panacea

Target date funds are usually mutual funds that mix stocks, bonds, and other investments. They can be turnkey options for retirement savers because their motivation is based on a target retirement date. When employees do not make their own investment choices, plan sponsors usually provide target date funds as the default option.

Since target date funds provide you with a diversified portfolio, they may be a good choice for young investors who may not have other investments outside of the 401(k) plan. However, when you accumulate diversified investments beyond 401(k), you may need to consider adjusting your 401(k) investment to suit your overall investment situation.

One of the big selling points touted by target date fund issuers is the downward path. If you are still decades away from retirement, the fund will contain more growth-oriented investments. As you approach retirement, the fund will shift to a more conservative portfolio. Before deciding whether it is suitable for your retirement situation, it is important to understand the downward path of any target date fund you are considering. Also, pay attention to fees: some target-date funds have higher costs than other good retirement options, such as index funds and ETFs.

The value of financial advice

As you grow older, the assets you manage may become more complex, and may include your IRA, annuities, spouse’s retirement plans, pensions, taxable investments, and other assets. Hiring a financial advisor to help you review your current 401(k) plan in the context of these other investments can help you make the most of your 401(k).

Many plans provide participants with opportunities to obtain investment advice through their plan providers or online services, sometimes for a fee. The quality of the advice varies, so please do your homework in advance. Ask whether the proposal takes into account any external investment and your overall situation.

Bottom line

Taking action early and consistently in your working life is the key to maximizing the value of your 401(k) account and becoming a 401(k) millionaire. Continue to contribute, invest according to your situation, don’t ignore your old 401(k) account, and seek advice when needed.

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