You have a 401(k) through your employer and you dutifully contribute a percentage of each paycheck to it, confident you’re ahead of the game. After all, many people don’t have a retirement account at all. While this is true, if you crunch the numbers, you may be surprised to find that you’re not as far ahead as you thought.
A 401(k) can be a great way to save for the future, especially if your employer matches your contributions. But they do have their limitations.
Here are a few things you need to know about using your 401(k) to save for retirement, along with some advice on how to boost your retirement savings even further.
Not all of the money in your 401(k) is yours
Traditional 401(k)s are tax-deferred, which means that you don’t pay any taxes on the money until you withdraw it from the account. The tax brackets change slightly every year, but most people can probably expect to give away at least 10 percent to 25 percent of that money to Uncle Sam.
You also need to keep in mind that inflation will likely erode the value of the dollar even further over the next few decades, so you probably won’t be able to live as comfortably on $40,000 in 30 years as you do today. While it’s impossible to predict the exact rate of inflation, many experts recommend assuming a 3 percent annual inflation rate when calculating how much you need to save for retirement. So for example, if your living expenses amount to $40,000 this year, they may be $41,200 next year and $42,400 the year after that.
Your 401(k) also has a number of administrative fees that can eat into your profits. If you like the portfolio that you have and you’re earning a good return, these fees may not affect you significantly. But if you haven’t profited that much from your current 401(k), paying these extra fees may not be worth it. You can learn more about what fees you’re paying by checking out your 401(k)’s prospectus or talking to your employer about the plan.
You probably aren’t contributing enough
About one-third of Americans with a 401(k) are contributing 4 percent or less of their paychecks each month, according to a Vanguard survey. While it’s true that compound interest is on your side, especially if you start investing early, this may not be enough for you to live on in retirement.
The median salary for workers in the U.S. is $44,564 per year, according to the Bureau of Labor Statistics. Let’s assume you contribute 4 percent of that to your 401(k) every pay period for 30 years. Assuming your salary keeps pace with our 3 percent inflation estimate, your 401(k) will be worth just $299,140 by the time you’re ready to retire. When you add in taxes and inflation, this amount probably won’t even last you a decade.
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Source: USA Today