How does the Retirement 401(k) Calculator works
The retirement calculator 401(k) is designed specifically to show you how well your current retirement savings pattern will prepare you for retirement. It will also show you the impact of investment fees on your portfolio performance.
Let’s go through the specific steps of how to use the retirement calculator 401(k), line by line:
Your basic info:
- Your current age: Enter your current age or the age at which you will begin your 401(k) plan.
- Your current yearly income (before tax): Your plan contributions will be based on your gross income before taxes and payroll deductions, like health insurance premiums.
- How much you have already saved in your 401(k) account: Include the entire balance, not just the vested portion.
401(k) contributions:
- Monthly 401(k) contributions: This is really the percentage of your income you’re currently contributing to your plan. For 2023 it cannot exceed $22,500 per year, or $30,000 if you are 50 or older.
- Employer match: This is the percentage of your contribution that your employer matches. With most employers that offer a match, the percentage is 50%.
- Limit on matching contributions: Your employer may match 50% of your contributions, but only up to a specific limit. For example, a 50% match up to a total employer contribution of 3% is typical.
- Include 401(k) fees: Unless investing for your 401(k) plan doesn’t require any investment fees, you should check the “Calculate fees” button.
- Total 401(k) fees: Your 401(k) plan summary should indicate the dollar amount and percentage you’re paying in fees for your current investing activities. Enter that percentage using the slide.
Once you’ve entered all the information above, hit the “Calculate” button to get your results.
401(k) savings summary:
- 401(k) balance at retirement (age 67): The retirement calculator 401(k) defaults to age 67, since that’s the age of full retirement for anyone born in 1960 or later. This box will show the full dollar amount of funds accumulated in your plan by that age.
- Your 401(k) will contribute: This box will display the monthly income you can expect from the retirement portfolio amount shown in the previous box.
- Based on your current income you will need about: This result will be based on 80% of your pre-retirement income. That’s the percentage typically recommended by retirement planners to maintain your standard of living once you retire. If the “Your 401(k) will contribute” result is higher than the “Based on your current income you’ll need about” result, your 401(k) plan distributions will provide all the income you’ll need in retirement. If it’s less, you’ll need to either increase your contributions, or plan to rely on other income sources, like Social Security, a company pension, or investments held outside your 401(k) plan.
- 401(k) fees: This is an often-overlooked aspect of investing for retirement. But as the retirement calculator 401(k) will demonstrate, these can have a major impact on your investment results. The calculator will show this through the remaining two results (cost of fees and 401(k) balance at retirement including fees).
- Cost of fees: This box will display the dollar amount of fees you will pay between now and the time you retire, based on the “Total 401(k) fees” annual percentage you entered earlier.
- 401(k) balance at retirement (incl. fees): This result will display the net amount of funds in your plan after deducting the cost of fees. It will be the “401(k) balance at retirement (age 67)” result, less the “Cost of fees” result.
What’s a 401(k)?
A 401(k) plan is an employer-sponsored retirement plan commonly used by for-profit employers, particularly large corporations. Because of the many benefits they provide, you should participate in a 401(k) plan if it’s offered by your employer.
For 2023, you can contribute up to $22,500 per year, or $30,000 if you are 50 or older. What’s more – in theory at least – you can contribute up to 100% of your earned income with your employer, up to the maximum contribution limits.
Employer matching contributions
Many 401(k) plans offer an employer matching contribution. Typically, an employer will match 50% of your contributions to the plan, up to a specific percentage limit, like 3% or 5%. With some more generous employers, the matching contribution may be 100%, with a total limit of 10%.
I’ll give you an example: let’s say you earn $100,000 per year, and you contribute 15% of your salary, or $15,000, to the plan each year. If your employer offers a 50% match, up to 5% of your salary, they’ll contribute an additional $5,000 per year.
If you’re not sure what percentage of your income to contribute to your 401(k) plan, you should at least contribute enough to maximize the employer matching contribution. Since the employer matching contribution is virtually free money, you should always do what you can to at least contribute a percentage that will maximize that match.
Two vesting schedules
You should also be aware that employer matching contributions almost always come with a vesting schedule. A vesting schedule is a formula that determines the percentage of the employer match that becomes permanently yours, and at what point in the process. But if you leave the job before the funds are vested, they’ll revert back to the employer.
Under IRS regulations, there are two vesting schedules.
- Cliff vesting is about what the name implies. For the first two years you participate in the plan, the employer matching contributions are not vested. However, after two years, your contributions become 100% vested.
- Graded vesting involves a stair-step type of vesting. For example, you may be 0% vested after one year of service. In the second year, you’ll be 20% vested. Vesting will increase by 20 percentage points each year thereafter until you will become 100% vested in the sixth year of service.
As you might imagine, employers apply vesting schedules to matching contributions as an incentive for employees to remain with the company, at least until they’re fully vested in the 401(k) plan.
Multiple types of 401(k) plans
A 401(k) isn’t just one type of plan, but several:
Traditional 401(k)
This is the most common type of plan offered by employers. Your contributions are fully tax-deductible, often include an employer match, and investment earnings accumulate on a tax-deferred basis.
Once you reach age 59 ½, you can begin making withdrawals, which will be subject to ordinary income tax. If you make withdrawals prior to reaching that age, you may pay a 10% early withdrawal penalty in addition to ordinary income tax. Traditional 401(k) plans often offer loan provisions.
Roth 401(k)
A growing number of employers are now offering a Roth 401(k) option. In most cases, you’ll be able to allocate some or even all your 401(k) contributions to the Roth 401(k) portion. Your contributions to the Roth portion will not be tax-deductible.
However, distributions from the plan can be taken tax-free once you reach 59 ½, and have been in the plan for a minimum of five years.
If your employer offers a matching contribution, the funds must be placed into a traditional 401(k), since those distributions will not be tax-free.
Solo 401(k)
As the name implies, this is a 401(k) plan for a single participant, who is self-employed. However, the plan allows the business owner’s spouse to also participate in the plan. It works just like a traditional 401(k) plan, in that you can make contributions up to $22,500 (or $30,000 if you’re 50 or older) as your employee contributions.
But since you’re self-employed, you act as both employee and employer in a solo 401(k) arrangement. In addition to your employee contributions, you can also contribute up to 25% of your net income as an employer matching contribution. Total contributions from both employee (you) and your company can’t exceed $66,000 in 2023
Self-directed 401(k) plans
A self-directed 401(k) plan is one in which the individual handles the investment selection and management of the plan.
Of course, this is typical of solo 401(k) plans. But some employer plans offer the self-directed option by holding the plan with an investment brokerage firm. The employee can then select from the wide range of investment options offered by the custodian.
Why you need to start saving for retirement when you’re young
While the amount of money you contribute to your 401(k) plan each year will have a major impact on the size of your portfolio at retirement, the age at which you begin saving is equally important. This has to do with the time value of money – the more years you have to invest, the bigger your plan will get.
Let’s say we have two new employees working at the same company. One is 40, and the other is 25. Each begins contributing to the company 401(k) plan, with an annual investment rate of return of 7%.
- The 40-year-old earns $100,000 per year, and contributes 15% – or $15,000 – each year. By age 65, he has accumulated $984,342.
- The 25-year-old earns $50,000 per year, and also contributes 15% – or $7,500 – each year. By age 65, she has accumulated $1,553,463.
Notice that even though the second employee makes contributions only half as large as the first, she has almost 60% more funds in her 401(k) plan by age 65 – just as a result of having an additional 15 years of contributions.
The moral of the story: the sooner you start participating in a 401(k) plan, the stronger you’ll finish.
Where to save for retirement
Unfortunately, the vast majority of employer-sponsored retirement plans don’t give you an option as to where to invest your money. The employer or the plan administrator chooses the plan custodian, and your investment options will be limited by those offered by that platform. There are a variety of custodian types available, depending on which your account operates in.
Fund families
Many 401(k) plans are established with fund families that offer primarily mutual funds and/or exchange-traded funds (ETFs). Depending on the size of the fund family, you may either be limited to a small number of funds to invest in – or many hundreds.
If your plan is held in a fund family, your goal will be to come up with the best mix of funds to reach your investment goals.
Robo-advisors
Automated, online investment management services have become increasingly popular – and for good reason. Though they currently exist primarily for taxable investment accounts, they’re slowly becoming available for large retirement plans. They are an excellent option for anyone who has limited investment experience and prefers to have professional management at a low cost.
For example, Betterment has recently rolled out a robo-advisor service specifically for 401(k) plans. Unfortunately, whether or not your plan uses a robo-advisor is beyond your control. Once again, either the employer or the plan administrator will decide on this option.
If you’re working for a small employer, and you like the robo-advisor concept, you may want to suggest investigating this option to your company.
Investment brokers
These are investment platforms that offer diversified investments. They have the advantage of enabling you to choose to invest your money any way you want. That can be investing in individual stocks, bonds, mutual funds, ETFs, real estate investment trusts (REITs), or even options.
This is the perfect custodian for experienced investors who prefer to engage in self-directed investing. Not only do they offer a wide range of investment products, but they also provide valuable tools and research, as well as customer service, to help you with your investing efforts.
Getting help with your 401(k) –wherever it is
One of the unfortunate realities when it comes to 401(k) plans is that we are generally on our own to manage them.
This is a serious problem since many people have little or no investment experience at all. But if this describes you, there is a service you can use that will manage your 401(k) plan for you, and at a very low fee.
For an annual fee of just $120 – or $10 per month – blooom will provide full investment management of your 401(k) plan for you. That will include creating the proper asset allocations, emphasizing the lowest cost funds available in your plan, and even rebalancing your portfolio to keep those allocations consistent with the target goals.
But best of all, blooom can work with any 401(k) plan. You can simply add it to your plan – participation by your employer or plan administrator is not required. You’ll even have access to live financial advisors.
So I’d say that if you’ve been having difficulty successfully managing your 401(k) plan, blooom may be the solution to your problem.
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