Your 401(k) balance on the eve of retirement obviously depends on how much you save over your working life and on the performance of your investments. But there are other factors that influence the size of your next egg, including how early you start saving and when you leave the workforce. Fees, expenses, and early 401(k) withdrawals can affect your investment returns as well. Here are eight factors that determine the final balance of your 401(k).
When you begin saving. Workers who start saving for retirement in their 20s and follow through often have the most impressive 401(k) balances. "The biggest influential factor is definitely when you start saving," says Josh McWhorter, president of Black Oak Asset Management in Cartersville, Ga. Money you save in your 20s and 30s has decades of compounding ahead of it. For example, a worker who saves $5,000 each year between ages 25 and 65 and earns 5 percent interest would have $634,199 in retirement. An employee who saved the same amount annually but didn't start until age 35 would have just $348,804.
Saving continuously. It is important to save regularly for retirement. "Make it like a payment, almost like your utility bill and your car payment or your school loan," says Ted Sarenski, an accountant who specializes in personal finance in Syracuse, N.Y. "The consistency gets you in the habit of doing it so when other things come up, you consider it a bill." If you switch into a new job without a 401(k) plan, set up your own retirement account. "If they don't have any type of pension plan, you should then do a contribution to an IRA," says Sarenski.
Retirement date. Delaying retirement packs the double punch of giving you more time to save and shortening the number of years over which your savings must be spread. "Now you've got a couple more years to accumulate, and you have a couple less years to spend it, so your need is going to decrease," says Rob Garcia, a financial planner and CEO of Rob Garcia Wealth Management in Templeton, Calif. Older workers are also eligible to contribute higher amounts to 401(k)'s. Those ages 50 and older can tuck away $22,000 in a 401(k) in 2010, $5,500 more than the $16,500 younger workers can contribute to their tax-deferred account at work this year.
Earnings. Workers with higher earnings generally have an easier time saving some of that money for retirement. While 69 percent of wage and salary workers earning more than $50,000 in 2008 participated in a retirement plan, just a quarter of those earning less than $20,000 tucked money away for retirement, according to the Employee Benefit Research Institute. As you move up the wage ladder, consider having part of your raise directly deposited into a retirement account. In many 401(k) plans, those with higher earnings also get a higher dollar value for their 401(k) match. For example, if an employer matches 3 percent of pay, an employee earning $30,000 could get a maximum of $900, while a worker with a $70,000 salary could claim up to $2,100.
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Employer contributions. A employer 401(k) match that is vested is an instant return on your investment. Maximizing your company's 401(k) contribution will pay off in retirement. "You want to do at least what you need to do to get that match in full," says Sarenski. But some employer contributions are far more generous than others, generally ranging from less than 25 cents to more than a dollar for each dollar an employee saves. "If you are comparing job offers, go with the company that has a match to their 401(k) rather than one that doesn't," says Sarenski.
Asset allocation. Retirement savers need to balance safety with the need to build wealth. "As your retirement account gets larger, if you don't manage those assets properly, that can have a huge affect as you approach retirement," says Garcia. "Getting more conservative closer to retirement is usually the right choice." Once you find an asset allocation that balances your needs for rewards and safety, stick with it regardless of daily stock market updates. "I think diversification is the key and not to chase returns," says Clyde Wyatt, a financial adviser and managing director of Navigation Financial Group in Dallas. "Systematic investments are by far the best way to accumulate long term to assets."
Fees. 401(k) fees and expenses cut into investment returns. "If you're paying an extra 1 or 2 percent in fees in addition to investment costs, that's going to play a huge role in your overall investments over time," says Garcia. In extreme cases, fund expenses can even cancel out your growth. "If there are 3 percent fees, you could actually be going backwards," says Sarenski. "The higher the fees, the less growth you are going to have on your 401(k) plan money."
Early withdrawals. 401(k) withdrawals before age 55 come with a 10 percent penalty in addition to income tax on the amount withdrawn. These early withdrawals can have a devastating effect on your final retirement account balance. For example, consider a 401(k) account holder born in 1970 who consistently saves 6 percent of pay annually from age 21 to age 65 and who gets a 3 percent employer match. If that person cashes out his or her balance once at age 35, it will result in $183,618 less in retirement than someone who didn't take any early withdrawals, according to Government Accountability Office calculations. To maintain the tax-deferred benefits of an old 401(k) account, leave it with an old employer, roll the balance over into an IRA, or transfer your savings to a new employer's 401(k).