Achieve the Unthinkable: Max Out Your 401(k)
The IRS recently increased the 401(k) maximum contribution limit from $17,500 to $18,000 for 2015, and if you’re like most Americans, you likely scoffed at the notion that anyone is capable of contributing that amount of money to a retirement account. If you fall in that category, then you’ve got a point. Vanguard reports that only 12 percent of its 401(k) plan participants deferred all $17,500 in 2013. The median deferral rate was 6.0 percent, while the number of participants deferring more than 10 percent was 22 percent.
The national median household income is $53,891 as of June, and although it’s fair to assume a good portion making below that amount are not enrolled in a 401(k) plan, let’s use that figure for some hypotheticals. Let’s say Joe Worker makes the median household income and contributes the median amount to his 401(k). That means he’s putting away $3,233.46 or 18.5 percent of 2014’s maximum contribution. That $500 boost from 2014 to 2015 doesn’t seem that relevant in that context.
It is relevant, though. Unless Joe Worker works an extra job and sells both cars, he’s not going to be able to max out his 401(k) in 2015. Fortunately, our lives aren’t static in nature. We’re a photo-obsessed culture because time doesn’t stand still. I’ve saved paystubs for nearly two decades now and none of them read the same. Other than a job change eight years ago that required a reduction in salary, the dollar amounts have consistently increased over the years. That’s a critical development because if we can avoid the temptation of lifestyle creep with each passing raise, regardless of how miniscule it may be, we can gradually increase our 401(k) contributions.
Let’s be optimistic and assume a two percent raise on average over the next 20 years. Inflation does its job along the way, of course, but in just keeping his deferral rate at 6.0 percent, Joe Worker’s contribution grows to $4,822.14. However, if he keeps 50 percent of the raise for cost of living increases and brushes the other 50 percent into his 401(k) each year, his deferral amount eventually grows to $12,859 after 20 years. That’s a significant yearly savings for someone making the median household income. Bump that initial income up to $75,000 and the final result is even more dramatic at $17,895.84. Add those yearly savings to a Social Security benefit and a healthy retirement emerges even without factoring in market returns.
There are plenty of resources across the financial world that will pull you in different directions regarding 401(k) participation and contributions, if you so allow. Regardless of interest rates, rate of returns, stock selections and any other variable that plays a role in determining your money’s future well being, the most important thing you can do is save as much as you can right now. Once you do that, make it a point to increase your savings rate every single year, through good times and bad.
The stock market will go up and the stock market will go down. Inflation will skyrocket as it did in the 1970s and it will drag the floor like its been doing for the last decade. Those variables are out of your control. Saving is very much in your control, and while I’m also a fan of the Roth IRA (that’s a blog post for another day), the 401(k) is beneficial because it’s out of sight, out of mind. You tell HR the percentage of your income that you want to deduct and it’s done. It’s incredibly difficult for a lot of us – myself included – to hold money in our hands and be responsible enough to move it to the appropriate savings box. Just the act of having to do something with the money, even right-clicking the mouse to transfer funds, creates an obstacle to our savings potential. The 401(k) is automatic, the money is subtracted off the top, thereby reducing your current taxes, and you don’t have to even think about saving money.