Maximize 401(k) Contributions

Retirement PlanOne of the first SavvyRecommendations was the PBS Frontline documentary, The Retirement Gamble, which notes that retirement is big business in America and wonders if the system is costing workers and retirees more than what they are getting in return. The bottom line as outlined in this documentary? Fees are a killer! No doubt that is true.

In September 2013, nearly one year ago, I offered The Failure of the 401(k) report, written by Robert Hiltonsmith of Demos, which concludes that retirement security has deteriorated in the past generation and that workers retiring in the next two decades can expect to receive only 65 percent during retirement of what they made during their working years; far below the amount required for Americans to enjoy a secure and dignified retirement.

A Look at 401(k) Plan Fees [U.S. Department of Labor]

Considering these two SavvyRecommendations, one might conclude that I am not a fan of 401(k) plans. However, nothing could be further from the truth. In fact, I believe that 401(k)s can be a good retirement plan and are the best retirement vehicle available to the vast majority of workers.

Are there other investment options out there? Absolutely. However, they also have issues. How about real estate? Possible, but generally it takes a tremendous amount of capital to get started. Individual stocks traded in a brokerage account? Yep. It can be done. However, if you are going to trade stocks – assuming you don’t want to do it blindly or based on what your barber recommends – I suggest you prepare to commit a lot of time to studying financial statements and really learning about individual companies and their economic and competitive environments.

The Problem With 401(k) Plans [The Baseline Scenario]

There are two keys to taking advantage of 401(k) plans. First, something I have touched on previously, is to minimize fees. While good for the person/institution collecting the fees, they are not so great for you, the individual investor. Study the 401(k) documentation provided by the administrator of your plan. Pay careful attention to not only the objective of each of the respective available funds, but also the fees. If available, your best option will likely be index funds (including lifecycle, or target date, funds), which are able to keep their costs lower due to their passive management.

Second, you have to maximize contributions to your plan to reap greater benefits; namely a more comfortable retirement. To say that I am not a fan of the old maxim that you should contribute 10% of your salary to a 401(k) plan would be an understatement. I encourage people to think in absolute (i.e. exact dollar amounts) vice relative (i.e. as a percentage of something) with regards to investment goals.

Of course, it is likely that when you first start with a new employer and you are a younger individual, you will not be able to maximize contributions right away. That’s okay. The key is to start with what you can and develop a concrete plan to increase your contributions until you reach that goal. It is not enough to believe that you will maximize contributions “one day” with a vague plan about how and when it might happen. Specificity is important!

Maximize ContributionsThere will likely be three key factors to your plan. These are the three my wife and I considered as she slowly arrived at the point where she is now maximizing contributions to her plan: how much you can start with or are currently contributing, the frequency of your paydays, and anticipated increases to your salary.

For a number of years, her contributions were stagnant at about $10,500 per year while she pursued her college degree and we made some home improvements. However, about three years ago we made the decision to work toward maximizing her contributions. Her factors when we first formulated the plan? She was contributing $400 per paycheck, she gets paid 26 times per year ($400 x 26 = $10,400), and we anticipated that she would receive two pay increases per year & her car loan would be paid off about two years into the plan. The chart below illustrates execution of the plan. Note that she paid off her car loan in November 2012 and increased her contributions to $673 per paycheck ($673 x 26 = $17,498) late that year as we were positioning her to maximize her contributions in 2013 in anticipation of the IRS limit going from $17,000 to $17,500.

401(k) Chart

Your starting amount may be less than my wife’s and you may only be able to increase your contribution level by $25 per year. However, those are not the key factors. The most important elements are that you recognize you must maximize contributions and you must have a definitive plan for how you will get from point A – where you currently are – to point B – where you need to be. As noted by Winston Churchill, “He who fails to plan is planning to fail.”

And  you SavvyReader, are you embracing a 401(k) plan or its equivalents, such as the TSP?

Blogger-in-Chief here at RetirementSavvy and author of Sin City Greed, Cream City Hustle and RENDEZVOUS WITH RETIREMENT: A Guide to Getting Fiscally Fit.

14 Comments

  1. While some companies will just bill you about 10 or 15 percent, others might bill you 20 and even 25 percent.

  2. Awesome post! Fees are a killer – the startup I work for, FeeX, actually helps people find 401k fees (for free!) and even recommends lower-fee funds within your retirement plan. I think a lot of people pick 401k investments without even knowing fees are an issue, so awareness is super important.

    • “…a lot of people pick 401k investments without even knowing fees are an issue, so awareness is super important.” Absolutely! They are not aware of the fees themselves, nor the impact to compound interest and returns over the long-term. Thanks for stopping by, Molly. Always good to get another voice in on the conversation.

  3. I had always done the 10% standard a month and felt happy about it. Then when the market crashed I got pretty worried, but our company brought in some consultants who showed us the numbers of what happens after the crash. We decided it was time to max out the 401k and start up the Roth and max that out as well. 6 years later with max out contributions (plus major kick in’s from my work) and a huge increase in the market and holy cow…life looks good (thank goodness for the advice and perspective early on), but we’re not content…just keep it going and grow, grow, grow along with contributions to other areas. Never give up, just do as much as you can, you never regret doing as much as you can, you only regret not starting sooner.

    • Good stuff, Lance. While starting at 10% is not necessarily a bad thing, I always encourage people to think in absolute, vice relative terms, and seek to maximize contributions. It is amazing one you start to see the exponential growth. That is one of the reasons I shared the value of my investment portfolio earlier this year. I wanted to show that someone can start from $0, and through consistent contributions and the power of time and compound interest, see great results.

      Thanks for stopping by and sharing your experience.

  4. Nice post! Just one thing to add: if your employer offers a Roth 401k option, look into it. I contribute half to my traditional 401k and half to a Roth 401k. Those dollars grow tax-free and there are no income limits, as there are with a regular Roth IRA. The only downside is you won’t be lowering your taxable income as much as if you did 100% traditional 401k, but, for me, the upside to having tax-free money in the future outweighs that fact.

    Have a great week!

    • Contributing to both if your employer offers the Roth 401(k) option is certainly something that should be considered, dependent upon how an individual’s retirement portfolio is configured for taxes now and in the future. I maintain separate 401(k) and Roth IRA accounts and maximize contributions to both, which is what I would suggest should be the goal for most individuals. Thanks for stopping by and adding to the conversation, Rob.

  5. Great post. Minimizing fees is tough on the 401k side because some plans just offer such horrible investment options. I’ve sat down with several friends and have been shocked that the lowest ER for the offered funds was near 1%. Insane!
    We considered contributing a huge portion of my wife’s paycheck toward the end of the year to her 401k, but ultimately decided that the after tax money is more valuable right now for Roth’s and finishing out student loan debt.

    • Thanks so much for stopping by, Jacob. No doubt that some plans not only have poor investment options but also have unnecessarily high fees. I am also a fan of Roth IRAs and it sounds like your decision to contribute to a Roth and pay off student loans, vice contributing more to your wife’s 401(k), is a sound decision. As I note in the post, I do believe that a 401(k) is among the best, if not the best retirement vehicle for most people, primarily because the contribution limits exceed that of the other popular retirement vehicle, IRAs – Traditional and Roth. What I did not mention in the post is that I believe the ultimate goal for people is to maximize contributions to both 401(k)s and IRAs; therefore, it does not become a case of choosing between the two. Again, appreciate you taking the time to leave a comment and I hope you visit again.

    • You raise a valid point about some 401(k) plans. I once worked for a smaller firm whose 401(k) was pretty low quality (and high fees). In that scenario my priorities would be:
      1) Contribute enough in the 401(k) to get whatever match the employer happens to provide. If your employer matches donations that ‘free money’ usually outweights the plan’s fees. My current employer matches to $4,000.
      2) Maximize the IRA at a very low-cost firm — something like Fidelity or Vanguard
      3) Finish the 401(k) if you still have funds left to contribute.

      In your case, with student loan debt I agree with your priority of paying it down now, while you’re still young — I’d get that knocked out as soon as possible.

      • Great input, Jean. I just read an article this morning in USA Today and in an interview with a vice president at Fidelity, she noted that last year they did a study of 401(k) millionaires in Fidelity-administered plans, and one of the key things they did to save their way to a million dollars was to take full advantage of their employer 401(k) match and profit sharing. About 28% of their 401(k) balances came from their employer. That includes their employers’ contributions and the growth on those contributions. That is huge!

        I’m all over the Fidelity or Vanguard suggestion. Couldn’t agree more. The wife and I maintain brokerage, IRA and cash management accounts with Fidelity. A wide variety of options with low, reasonable fees.

  6. This is something I’m currently working on myself–how much more do I need to increase my contribution until I reach the maximum while considering when other bills will be paid off. My contribution amount will change for the remainder of this year and then a new set for the coming year.

    Excellent post!!

    • Great to have you stop by and chime in, Leona. As you note, I believe the key is to look for ways to increase contributions while considering other financial obligations.

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