Many 401(k) holders are very happy to have a retirement plan—and they should be. The 401(k) is the most common employer-sponsored retirement plan that exists today and one of its many benefits is that employers match a certain percentage of the contribution made by the employee. It’s no surprise that a common piece of advice is to contribute at least the percentage of your income matched by your employer.
But a lot of people don’t know that they can give their 401(k) retirement plan a truly significant boost by doing one simple thing: raising their 401(k) contribution rate.
This may seem like obvious advice, but most Millennials (particularly Americans in their 20s) contribute, on average, less than 10% of their income. Surprisingly, older demographics aren’t doing much better: those in their 60s only contribute slightly over 10%.
The impact of raising your 401(k) contribution rate
Increasing your contribution rate can have a profound impact on the performance of your account in the long run. It can be difficult to grasp just how much of a difference increasing your rate can make, which may explain why so many Americans never adjust their contribution rate.
Let’s take as an example of a 25 year old with a salary of $50,000 (without taking raises into account), an annual rate of return of 7%, and a 100% employer match up to 4%:
- Contributing 5% yields only $932,069 after 40 years
- Contributing 15% yields more than twice that amount at $1,967,709 after 40 years
But that’s not all. Not increasing your 401(k) rate just doesn’t keep it real. Why? Let’s talk about a few things.
Take inflation into account
Inflation is inevitable and it applies to both the economy as a whole and individual finances. As time goes on, the cost of living increases, but often times financial growth does not. Increasing your 401(k) rate fills the huge gap inflation creates between money and affordability over several decades.
Remember that the amount of money you think would be enough to live on for 20 or 30 years today will not be the same amount required in another 40 years.
A good rule of thumb is to increase your rate every time you get a raise; better yet, steadily increase your rate every year regardless. Adjust your life to your savings, not the other way around.
Offset hidden fees
Many 401(k) plans have hidden fees that burden your saving ability. Employers are typically the ones who choose the plan provider and there is little employees can do about it. Most employees don’t pay attention to or understand where these fees come from or how they work. They’re usually found on the 12B1 column on the fee-disclosure section of the 401(k) plan.
This is how providers take their bite of the pie—and sometimes they can be a little hungry. So it’s important that you find out how much you’re paying in fees so that you can incorporate it into your retirement plan and not end up with an unexpectedly low balance.
Those who can contribute $500 from their 20s will become part of the 401(k) Millionaire club. But whether your monthly rate is above or below $500, one thing is for sure: contribution increases maximize savings and keep your 401(k) in touch with the reality of economic fluctuations, inflation, and cost of living.