Recently, I read an article that questioned how some people could build million dollar plus 401k balances. Depending upon your assumptions for how much money you will need in the future and how long you will live one might need $1 million plus balance. However, I believe that everyone does not need to make the sacrifices in order to attain a million-dollar balance. One should start with the question “how large of a 401k balance do I need?”
401k balance or retirement nest egg
I believe the question of how large a balance you need starts with whether or not your strategy for creating retirement income is analogous to having a chicken that produces eggs or eating the chicken. I believe most people are much better off having a chicken that produces eggs that can be consumed on a regular basis. This strategy would take the amount and converted it into some type of fixed annuity where you are transferring the risk of running out of money to insurance companies. Rather than give all of your money to one insurance company and expose yourself to the risk of default, you can diversify that risk by giving a portion to multiple insurance companies. Let’s say you need $50,000 in addition to what you are getting from outside pensions and Social Security. An insurance company may provide that amount by giving them say $500,000 of your money. The downside is if you die the day after you give them the money, you forfeit that which you’ve given them. However, the upside is that if you live longer, then you may receive more than what you would have gotten by pulling 10 years of $50,000 out of the principal.
The other strategy is to determine some kind of systematic spending of your nest egg. You could simply pull the money out of your account as needed or go with a systematic strategy of only pulling out a percentage. If you go with the “spend as you need” approach, you expose yourself to the risk of running out of money with no hedge. You could also choose to pull out a percentage from the accounts. Much research has said that number is likely around 4%. In layman’s terms that means that if you need $40,000 you would need a million-dollar 401k balance. The problem is that you still need to grow your money to head off the possibility of a long life. That means exposing yourself to the risk of the market. If the market goes down to $500,000, 4% means spending only $20,000. Determining which one of these withdrawal strategies best fits your comfort level and finances gives direction on the 401k balance size issue.
Calculating your 401k balance need
Financial planning is about balancing multiple goals and needs such as your children’s education, mitigating the risk of premature death, retirement planning, emergency funds, etc. as you determine what balance is right for you (See letsmakeaplan.org). You may determine that one of these withdrawal strategies emerges as the one that best suits you. How might this work. Assume:
- You want to live on $75,000 at the start of retirement
- Social Security will pay $25,000 at the start of retirement
- You have no pensions
- Inflation will hover around 4%
- Your 401k balance needs to provide $50,000/yr and 4% annual raises
- Your risk comfort suggests a portfolio that is half stock and half bonds (See Risk page)
You like the strategy of passing the risk onto an insurance company, and target a 401k balance that can be converted into fixed annuity with a 4% cost-of-living adjustment at retirement. Let’s say that will likely cost you somewhere in the neighborhood of $600,000 to $800,000 at the start of retirement. There are several factors that might vary that amount. Those issues are outside of this blog. Suffice it to say that as you get closer to retirement you and your advisory team can make adjustments.
What is your plan for growing your 401k balance?
If you’re like most people you have not had a CERTIFIED FINANCIAL PLANNER™ professional or other credentialed financial planning designation help you calculate your savings need. Adding a retirement spending strategy (how you will withdraw your money) likely adds a new wrinkle into that calculation. While plans are great, implementing them is even better. If you’re like most people the challenge becomes in implementing the key inputs of the plan-saving, getting consistent market returns and sticking with your plan.
That’s why believe it is imperative that you work with a credentialed financial planner, like a CERTIFIED FINANCIAL PLANNER™ professional. Research by Unified Trust uncovered that savings is 45 times more important than investment returns in helping savers reach 401k balance targets. Investor behavior is known to sink many an investment plan. Research from Charles Schwab found that 401(k) savers that work with a financial professional generally save more and get better returns. Don’t you owe it to yourself and those that you love to get help? One way for us to help get you on the right path is to start with an assessment of your comfort with risk. This webpage will explain the process and how that leads us into helping fine-tune a retirement plan to help you on your road to retiring on your own terms. If not us, then who? If not now, then when?
Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 are subject to a 10% IRS penalty tax and surrender charges may apply. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Examples used are hypothetical and are not representative of any specific investment. Your results may vary.