1/17/2012 5:00 PM ET|
Secrets of the 401k millionaires
Members of this rare class of savers -- just 0.2% of 401k owners -- don't necessarily have higher salaries or the investing IQs of Warren Buffett, advisers say.
Those hoping to occupy Easy Street in retirement may want to follow the lead of the 0.2% -- that topmost tiny fraction of savers who have managed to sock away more than $1 million in their 401ks.
That figure, based on data from the Employee Benefit Research Institute, may depress those with sums closer to the median 401k balance of roughly $60,000 -- and for good reason. Even among employees 55 and up who have been contributing to the same 401k plan for more than 20 years, just 2% are estimated to have cracked the $1 million mark, says Jack VanDerhei, EBRI's research director.
To some, the remaining 98% of savers 55 and older who haven't cracked $1 million show that the 401k, the principal vehicle for U.S. retirement savings, is at best inadequate and at worst a colossal failure. Even Ted Benna, the man credited with developing the first 401k plans out of an IRS tax loophole in 1981, now concedes that they've grown overly complex, with too many options, too-high fees and too many ways to cash out one's nest egg.
401k providers aren't happy, either
Even some 401k providers don't disagree. With traditional pensions, employers hired teams of experts to make the tough investing decisions now entrusted to individual employees, says Catherine Golladay, vice president of participant services for Charles Schwab. "Left to their own devices, most people do not have the knowledge or the discipline to do this themselves," she says.
Schwab, like other 401k providers, has found that efforts to educate employees haven't proved to be very successful -- and that only 10% of workers take advantage of such offers of help. In response, the company has announced a new index-fund-only 401k, which will keep expenses down and include mandatory advice on investments. "Many employees don't understand what they are losing to expenses -- sometimes 55 to 110 basis points," says Jim McCool, an executive vice president at Schwab. "They don't realize what a drag it is on their retirement savings."
Target-date funds, which allocate investments based on the saver's age, have also proven inadequate, McCool says. "It's a cookie-cutter, one-size-fits-all approach. We're hoping that by adding independent, one-on-one advice, we can help tailor plans to the needs of individuals and stop them from panicking and making bad decisions when the market gets scary."
How some make it work
So if that's what's wrong with the 401k, who are these super-rich among retirement savers who have managed to make the system work? And what are they doing differently? They don't necessarily have higher than average salaries or the investing IQ of Warren Buffett, VanDerhei says. "The one characteristic that differentiates the winners from the nonwinners here is contribution rate -- a high percentage of those million-dollar savers had constant participation and high contribution rates," he says.
Though many savers may be scarred by the past decade of lousy returns, getting to $1 million over the course of a 40-year career should be a manageable goal -- even for some lower-income employees, says Greg Burrows, a vice president of Principal Financial. Someone who earns $35,000, saves 12% to 13% (including a company match) and who gets an annual raise of 3.5% and annual returns of 7% would save a million dollars.
Despite the current volatility, many may still do that, he says. "One thing you have to keep in mind is that the 401k hasn't been around long enough for us to see people take full advantage of it over the course of an entire career."
Of course, those who earn big salaries are more likely to have big balances in their 401k's, says Mike Alfred, the CEO of Brightscope, which monitors and rates retirement plans. Further, the Great Recession not only wiped out many 401k balances, but its fallout also has hampered saving -- particularly among the middle class, he says. "There are a lot of families who have to simply stop saving because of a job loss or major health-care issue," he says.
On top of that, most participants can't -- or don't -- take full advantage of their 401k's, says Alfred. Advisers recommend savers max out their 401k contributions. But while the IRS raised the cap $500 to $17,000 for 2012, just 9% contribute the maximum, according to EBRI.
And to put $1 million in perspective: As nest eggs go, it's not exactly Fabergé. The rule of thumb, advisers say, is to accumulate enough to be able to replace 75% to 80% of one's income in retirement, without -- ideally -- having to draw down more than 5% of the balance per year. So a $1 million nest egg would give off just $50,000 annually, enough to replace 75% of the income of someone who made $66,666. Even if the retiree collects the current maximum Social Security payment of $30,156 annually for a total income of $80,156, that's still just the recommended replacement for an annual income of $106,874.
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I am one of those lower earning people who have a pretty large balance in my 403b (401k equivalent) yet have never earned more than $66k, in fact the past several years have hovered around $50k, and never contributed more than 4% to the account.. The key is consistency and persistence (I started contributing in my twenties). I did pay attention to the mutual funds offered and would rebalance or change my choices from time to time, but not always even yearly. If I had put aside more I might be creeping up on that one million mark, but I think that I am in good shape anyway. I also contribute any left over funds after my budgeted spending to an IRA.
Yes, I lost some value in the stock market crash but stayed invested and have not just recouped but have exceeded, so I have never quite understood what the doom & gloom was about. That is the inherent risk/reward of investing -- being in a 401k is a good vehicle for that, but if you don't want to take the risk then put your money in bank CDs (and be sure to be behind in the end).
Anyone investing in 401k via wall street learned nothing from the last robbery of the 401k. It is plain as the nose on your face now that the rich can and will lie and pull the rug out from under the rest of us. Just put your money in your mattress, or even a local credit union. Don't let those greedy liars that run wall street control your life. Viva Occupy Wall Street
I had to cash in all my IRA's etc. to get a house in my mid 30's So I started from scratch, yet I was still able to retire at 55 with my retirement funds paying out more than my SS. 401K's, IRA's, etc. are wonderful if you do your homework. We used funds until they stopped performing, then we educated ourselves on investing and transferred assets to self directed funds where they is NO fee and we make the decisions.
The dirty little secret is most funds actually lose money over time so you have to keep an eye on them and be willing to move the money around. Optimum is self directing where you make all the investment decisions but that takes even more homework. The increased gains are well worth it however.
I have also seen many millionaires in 401ks wiped out by investing 100% on their money in company stock, chasing hot stocks or hot sectors in their self-directed portion of their 401k and by not diversifying ( i.e. 100% in stocks just before they want to retire ) before the 2008 crash.
To those that made the million dollar plus 401k Club my hat is off to you. Many of you did it the right way by being disciplined, frugal and by educating yourselves on investing. But, many people in this group where at the right place at the right time with the great bull market lasting from 1982-2000. So, there are people in this elite group that got there by sheer dumb luck. Retirement for the masses shouldn't be this way.
If Congress doesn't act on retirement reform, decades from now they will see 60+ year olds flat broke counting on Social Security more then ever which in no way will be come close to satisfying anyone's retirement goals. Congress needs to look at simplifying, and lowering drastically the costs of the Defined Benefit Plan to employers and making them portable but untouchable to employees. This would solve many of the deficiencies as having the 401k as a primary retirement vehicle and helping us little people retire.
The problem with saving in 401ks is that most people dont do it correctly. Most people get more financial "advice" from the person in the cubicle next to them then actually sitting down with someone that can help them. For instance...why put 17,000 a year into a taxable account? In fact, why put more than a company match into a 401k plan with limited funds? In doing so, you are putting your dollars at the mercy of a few "target date" funds allof which will be taxable on the back end. So that $1,000,000 401k actually will be worth...say....$700,000 and that's even if you have a separate account for college fees and other expenses so you dont have to dip into your 401k.
Most people lock themselves into the idea that the 401k is the best think around and should fund it as much as possible. If this is so...why are less than 20% of retired individuals financially independent? This approach does not work!
My recommendation.....Fund the 401k to get the full company match. Invest anything over that match into Roth IRA (if of course you are under the income maximums and are eligable) or other savings vehicles like non-qualified annuities. A Roth IRA is a tax deferred, tax free savings vehicle. And guess what.... 99.9% of the time you have access to more than the 25 funds available in your 401k. You have access to thousands!!! If you can't do the roth there are other ways to save. For instance...Varaible universal life insurance.....Basically a life insurance policy that has the characteristics of a Roth IRA (the cash value is invested in mutual fund positions). Dont be afraid of it being called "Life Insurance." The cash value grows tax deferred and is tax free when you pull it out....Life insurance is a bad thing right?
All of these are examples of course but take the time to sit down with an advisor. Find one that does not charge to do a plan for you and listen and consider what they have to say. I can almost assure you they know more than your buddy in the cube next to you. I can tell you...once we developed a plan, my clients feel much more content about their retirement savings. Please dont wait until a few years before you retire becaus you can't correct your mistakes as easily as planning in the long haul.
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