Why maxing out your 401(k) may not be enoughSubmitted by Financial Planning Solutions, LLC on May 2nd, 2019
Common financial wisdom is that you should ‘max out your 401(k) contributions’, right?
Rick and I have been discussing this common belief and I decided to do a few calculations on it.
What we discovered is that simple maxing out doesn’t provide enough, especially if you are single or divorced. Upper-income folks will have to save more in order to provide enough income in retirement.
Assumptions: We assumed a single person who started to saving right out of college who had accumulated about $200,000 in his/her 401(k) by age 40. This hypothetical worker has a good job in a lucrative field. So, we decided that they would be earning about $127,000 at age 40. If from then on they made salary deferrals of 15% (a significant increase from their annual deferrals between age 21 & 40), until age 67, we project that they would have approximately, $713,000 in their 401(k).
At that point, they would live until age 90 (slightly beyond projected life expectancy). That resulted in annual payments of about $48,000, using a 4% rate of return. Because they would have reached the normal retirement age for Social Security benefits, we began payments at 67. We used the maximum benefit for a single person which comes out to around $36,000/year.
In sum, this is what it looks like:
Savings at age 40: $200,000
Salary at age 40: $127,000
Inflation adjusted salary at age 67: $216,000
Projected income provided by Social Security & 401(k) at age 67: $84,000/annually
Portion of SS & 401(k) that covers earnings at age 67—only 39% of working earnings!
As such, upper income individuals may find that just ‘maxing out their 401(k)’ is not enough. More commonly we see that people must save for retirement in many other ways, including IRAs, and other tax-deferred and taxable investment accounts in order to have enough assets to replace their income in retirement.
So, when you start feeling good about ‘maxing out your 401(k)’ take a second look and see if you are really saving enough to replace the income that you are enjoying today. Changes you make today could ensure that you have that carefree retirement you are expecting tomorrow.
Do you want to know if you are saving enough? Give us a call. We’re here to help.
Lyman H. Jackson
Limitations of this quick exercise: There are many. We did not do the kind of comprehensive financial calculations that we would normally do when we prepare a financial plan for a client. The difference is that a financial plan is comprehensive but, more importantly, the plan is customized to the particular clients’ lifestyle (e.g., income and spending patterns). This scenario only considers income, not income and expenses. Also, Social Security assumptions are based on benefits under current law, regardless of whether those benefits are funded or not.
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