Maximizing a ‘4’ plan


By Randy Neumann

Are you maximizing your 401(k)?
If not, why not?  Let’s begin by putting things in perspective. The national debt is $14 trillion.  The quote, “A billion here, a billion there, pretty soon you’re talking real money” is commonly attributed to Sen. Everett Dirksen from Illinois in the 1960s.  But some research reveals that the phrase was used as early as 1917.  And the Jan. 10, 1938, New York Times reported: “Well, now, about this new budget. It’s a billion here and a billion there, and by and by it begins to mount up into money.”
Trillions and billions are one thing, but millions are another.  Today, $1 million is not all that much money in terms of retirement savings.  In this “new normal” economy, a $1 million portfolio is expected to generate $50,000 annually in retirement income.  That’s for this year.  Using an inflation factor of 3%, next year’s income will be $48,500.  The following year will be $47,045, and so on.
Do you have $1 million in your retirement portfolio?  Will you need $1 million in your retirement portfolio?  You will if your retirement expenses are about $50,000, so how do you get there?
The hard way is to earn $100, pay the tax on it and put what’s left into a bank account.  If you are in the 30% tax bracket, you will pay the government $30 in tax, and you will invest $70 in an account that pays less than 2%.    Additionally, you will have to pay a tax on the earnings, so let’s say that you earn 1% net after taxes.  Your $100 is worth $70.70 at year-end.  If you apply a 3% inflation factor, your net amount is $67.90.
The easier way is to put $100 into your 401(k), 403(b) or 457 plans (hereafter referred to as “4” plans.)  The $100 goes in pre-tax, i.e., you pay no income tax on it.  The money grows tax deferred as long as it stays in the account and can, in most cases, be invested in a diverse menu of investment options so that you can manage the risk in the account.
Back to the question at hand.  Are you maximizing your “4” plan?  When something is good for the government, there is no limit.  When something is good for us (the taxpayer), there are limits.  This year’s limit to “4” plans is $16,500.  If you are over age 50, you can make an additional “catch-up” contribution of $5,500.
Let’s look at a plan in motion.
As mentioned above, “4” plans provide tax-deferred growth and compounding, so the money in your 401(k) compounds year after year without tax penalties.  The earlier you start, the more compounding you get.  Assume that you put $2,400 annually into a 401(k) starting at age 30, and for the sake of example, let’s assume you get an 8% annual return.  How much money would you have at 65?  You would have a retirement nest egg of $437,148 from putting in $200 per month.
Interestingly, if you started putting in the same $200 a month five years later, you would have only $285,588.  Time is money.
But you may not have to do all of the heavy lifting yourself.  According to some research done by Money magazine in 2010, big companies will often match employee 401(k) contribution.  Usually, this match is 50 cents for each dollar up to 6% of salary.
And, there’s also a new wrinkle in the “4” plans—the Roth element.  Contributions to a Roth “4” plan are not tax-deductible, the magic happens on the other end.  With these plans, you receive tax-free compounding and tax-free withdrawals (provided the withdrawals are considered qualified).
Let’s finish with the beginning concept of this column: trillions, billions and millions.  Assuming an 8% annual return, to retire with $1 million all you need to do at age 30 is put $6,000 per year ($230.76 per biweekly paycheck) into a “4” plan until you are age 65 at which time you will have $1,000,033.90 in your “4” plan.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual.  Randy Neumann CFP® is a registered representative with securities and insurance offered through LPL Financial.  Member FINRA/SIPC.  He can be reached at 12 Route 17N, Suite 115, Paramus, 201-291-9000.

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