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How Much Income Will Your 401k Provide

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It’s Not About Money It’s About Income

How much to contribute to your 401k? | FinTips

One important point when it comes to determining your retirement “number” is that it isn’t about deciding on a certain amount of savings. For example, the most common retirement goal among Americans is a $1 million nest egg. But this is faulty logic.

The most important factor in determining how much you need to retire is whether you’ll have enough money to create the income you need to support your desired quality of life after you retire. Will a $1 million savings balance allow you to create enough income forever? Maybe, but maybe not. That’s what we’re going to determine in the next few sections.

Helping To Answer The Looming Retirement Question: Will I Have Enough

Retirement account owners have long had trouble translating the money in their 401 into income.

Thats about to change.

Later this year, possibly in the third quarter, plan sponsors will be required to include two lifetime income illustrations on participants pension benefit statement at least once annually. In essence, the illustrations show how much income a participants account balance would produce in todays dollars if used to purchase either a single life annuity or a qualified joint and 100% survivor annuity.

And some are praising the new rule, despite the shortcomings to the Labor Departments interim final rule, which was required as part of The Setting Every Community up for Retirement Enhancement Act.

The final rule, when it goes into effect, should help those saving for retirement not only better understand how much income they will receive from their 401, but it will also give folks a fairly good idea if all their sources of income in retirement Social Security and defined-benefit plans, for instance will be enough to meet their expected expenses in retirement.

On paper, it all sounds great.

The defined contribution industry, in general, is in favor of the idea of lifetime income illustrations, said Drew Carrington, a senior vice president and head of institutional defined contribution at Franklin Templeton Investments.

So, what are some of the limitations?

So How Much Should You Invest In Your 401k

Okay. So, while investing is highly personal and financial goals should be personalized, you are here so we can teach you to be rich. We have some advice to get you started.

How much you should actually be investing each month depends on a system we call the Ladder of Personal Finance. It looks at three areas:

1. Your employers 401k match. Each month you should be contributing as much as you need to in order to get the most out of your companys 401k match. That means if your company offers a 5% match, you should be contributing AT LEAST 5% of your monthly income to your 401k each month.

Weve already discussed the importance of this dont throw away free money and the returns from that free money.

2. Whether youre in debt. Once youve committed yourself to contributing at least the employer match for your 401k, you need to make sure you dont have any debt. Remember, if you have employee matching, you are effectively earning a 100% return on every penny you invest in your 401k that is significantly more than the interest you would save by paying down your debt.

If you dont, great! If you do, thats okay. You can check out my system on eliminating debt fast to help you.

Also Check: How Does Retirement Work With 401k

Remember Required Minimum Distributions

While you don’t need to start taking distributions from your 401 the minute you stop working, you must begin taking required minimum distributions by April 1 following the year you turn 72. Some employer-sponsored plans may allow you to defer distributions until April 1 of the year after you retire, if you retire after age 72, but it is not common. Keep in mind that this exception does not apply to plans you may have with previous employers that you no longer work for.

If you wait until you are required to take your RMDs, you must begin withdrawing regular, periodic distributions calculated based on your life expectancy and account balance. While you may withdraw more in any given year, you cannot withdraw less than your RMD.

The age for RMDs used to be 70½, but following the passage of the Setting Every Community Up For Retirement Enhancement Act in Dec. 2019, it was raised to 72.

When You Retire You Have To Decide What To Do With Your 401 Money Generally Speaking You Will Have Some If Not All Of The Following Five Choices: Leave Your Money Parked In The Plan Take A Lump

How Much Should I Have in My 401k? (at Every Age)

Keep in mind, not all employers allow retired workers to remain participants in their 401 plan, but if yours does, here’s a quick look at the pros and cons of the various distribution options:

Lump-sum distribution

If you need a wad of cash right away, this option will serve that purpose. There are two key downsides: you forfeit the benefits of tax-deferred compounding by cashing out all at once and you’ll have to pay income taxes on your distribution for the tax year in which you take it, which can be a big bite out of your nest egg all at once.

Leave the money as is

Financial advisers often recommend retirees tap taxable accounts first in order to keep as much money growing tax-deferred as possible.

So if you’re retiring and have money outside of your 401 that you plan to live on, you may leave your account untouched until you’re 70-1/2. That’s when Uncle Sam requires all retirees to begin taking mandatory annual distributions from their 401s and traditional IRAs.

Of course, if your plan’s investment choices are very limited or have performed poorly relative to their peers, you might be better off rolling the money into an IRA.

Rolling money into an IRA

This is the option often recommended by financial advisers since an IRA offers greater investment choice and control, and is especially recommended if your plan has few investment options and not very good ones at that.

There are two advantages your 401 has over an IRA.

Periodic distributions


Also Check: Is There A Limit For 401k Contributions

Income Tax And Your 401k

Unfortunately, the relationship between tax and 401k is fairly complex. There are certain penalties and taxes that may apply to your 401k if you leave, for example. If you’re under the age of 59 and leave your employer, you might be subject to an early withdrawal penalty. You may not be able to avoid these consequences if you’re less than age 59 and need to leave your workplace. If you do, you might be subject to the 10 penalty. The 10 penalty refers to a 10% charge on the money you are owed.

Once you’ve left your former employer, any money that you get paid out in distributions or into your IRA is considered part of your taxable estate. As such, it is subject to a certain type of income tax.

More From Portfolio Perspective

The monthly amounts shown would be based on a worker’s current account balance and assume the payments were to start immediately and as if the person were age 67 .

Lifetime expectancy, used to determine how long those payments may last, would be based on a specific IRS mortality table and interest rate assumptions paid in the annuity would come from the 10-year Treasury bond’s then-current yield.

The interim rule includes an example: Say someone has an account balance of $125,000, and the interest rate used is 1.83%. The illustration would show that if the participant purchased a single annuity with that amount, they’d get $645 per month for life. For a joint annuity, the person would get $533 monthly until death and then that amount would go to the surviving spouse.

Of course, if the person is, say, 35, there are lots of years left to make contributions that will grow, which the illustration wouldn’t reflect. There has been some concern that for savers with lower balances, the numbers they see could be deflating if based solely on what they have accumulated so far.

“If you think about someone just starting out, and they make contributions for a year and then see they’d generate in monthly income, that’s not a strong incentive to save,” Berkowitz said. “That could be potentially troubling.”

It’s uncertain whether the final rule will include that recommendation.

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Anything Else I Should Know

Yep. A few things, actually.

  • Once you contribute to a 401, you should consider that money locked up for retirement. In general, distributions prior to age 59½ will be hit with a 10% penalty and income taxes.

  • If you leave a job, you can roll your 401 into a new 401 or an IRA at an online brokerage or robo-advisor. The IRA can give you more control over your account and allow you to access a larger investment selection.

  • 401s typically force you to begin taking distributions called required minimum distributions, or RMDs at age 72 or when you retire, whichever is later. You may be able to roll a Roth 401 into a Roth IRA to avoid RMDs.

  • What Is A Roth Ira

    4 Strategies To Get The Most Out Of Your 401k Plan

    A Roth IRA is an account that you can use to invest for retirement on your own, without an employer. You use after-tax dollars now, so you avoid paying taxes later on when it’s time for a distribution. The big difference between a Roth IRA and a Roth 401 is its flexibility.

    “Roth IRAs also allow penalty-free distributions for first-time home purchases, education expenses and unreimbursed medical expenses,” Amaral says.

    Roth IRAs are good for young investors who expect to be in a higher tax bracket later on. However, there are income eligibility requirements to contribute to a Roth IRA. The amount you can contribute is much less than a Roth 401. The maximum is $6,000, or $7,000 if you’re 50 or older. But it may be good in exchange for the flexibility a Roth IRA comes with.

    “While you can save more for retirement in a Roth 401, a Roth IRA offers more flexibility for withdrawals. With a Roth IRA, you are able to withdraw your contributions after five years to avoid any taxes or penalties,” notes Amaral.

    But first you need to see if you even qualify for a Roth IRA.

    One of the benefits a Roth IRA has over a Roth 401 is that there are no required distributions while the account owner is alive. So you can take money out when you want, and never be forced into it. The money can also be used for first time home-buying or health insurance premiums while unemployed, which makes it an attractive and flexible retirement savings vehicle.

    Recommended Reading: How Does 401k Work If You Quit

    Here’s How The Two Retirement Accounts Measure Up:

    Roth 401 Traditional 401
    Employer-sponsored Funded with post-tax dollars Withdrawals not taxed Can start withdrawing at age 59 ½ Must have had the account opened at least five years before making withdrawals Required minimum distributions starting at age 72 Employer-sponsored Funded with pre-tax dollars Withdrawals subject to income tax Can start withdrawing at age 59 ½ Required minimum distributions starting at age 72

    Quick tip: You may not have to pick one or the other. Some plans allow you to have both types of accounts. Just keep in mind the annual contribution limit is $19,500 total. , you could only contribute $9,500 to your Roth).

    Roth Ira Pros And Cons


    • You can withdraw funds tax-free.
    • Earnings on the investments grow tax free.
    • They have more flexibility with regards to the timing of withdrawals.
    • There are no minimum required distributions.
    • Contributions aren’t eligible for tax deductions.
    • There are income requirements in order to qualify.
    • They’re self-administered and have no employer match available.
    • The annual contribution limits are relatively low.

    Read Also: How Can I Find All Of My 401k Accounts

    Managing Taxes And Your 401k

    If you want to avoid paying tax on your entire 401k or age is an issue, you can choose to roll the money into an IRA. When you roll the money from your 401k to an IRA account, you can freeze most or all tax responsibility you have. This allows you to continue using the money for investment purposes as you did before. Once you’ve reached retirement age, you can withdraw the money in your IRA and use it however you’d like.

    Financial and tax advisors often recommend that you let the money stay in your IRA until you’ve reached retirement age. One reason is that the process of withdrawal can be somewhat messy and lengthy. Once you’ve started the process, you can’t go back. IRA accounts and 401k plans are subject to far less tax and regulation than regular types of investment. Unless you really need the money, you should let it stay in your IRA and use it for investment purposes. This allows you to generate a considerable quantity of passive income. Once you’ve retired, you should see the benefit of letting the money accumulate passively.

    Roth 401 Vs Roth Ira: At A Glance

    How much income will your 401(k) provide?

    The term 401 refers to the tax code in which these employer-sponsored plans were created. IRA stands for independent retirement arrangement. The key difference between the Roth versions of these types of accounts and their traditional counterparts is how the tax advantages work.

    • A Roth 401 is offered by employers. Similar to a traditional 401, this type of plan is provided as a benefit. Unlike a traditional 401, the contributions you make to a Roth 401 are with after-tax dollars. Qualified withdrawals are tax free.
    • A Roth IRA isn’t tied to an employer. If you meet the eligibility requirements, you can save for retirement using a Roth IRA through a brokerage like Fidelity or Vanguard and invest after-tax dollars. Qualified withdrawals are also tax free.

    “‘Roth’ means that the accounts are funded with after-tax dollars,” explains Brandon R. Amaral, a certified financial planner and founder at Amaral Financial Planning. “You don’t receive a tax deduction, however any growth in the account is tax free.”

    Also Check: How To Do A Direct 401k Rollover

    Determine Your Best Savings Rate

    Given the many variables, it may help to consider general rules of thumb to determine savings levels and percentages. Saving 10% of one’s annual pre-tax salary, for example, has generally been considered an adequate saving percentage. However, because people are living longer and don’t want to run out of money in their eighties or nineties, a savings rate of 15% or even higher has been proposed.

    A higher rate can also benefit those who didn’t start saving in their 20s and are now trying to catch up. Employers generally do match some of what their employees contribute to a 401, which can help in getting to a double-digit annual percent.

    In terms of estimating market returns, real returns on U.S. stocks have averaged around 7% over the past century. Real bond return levels have been much lower at 2%, while returns on short-term funds have been around 1%.

    Clearly, any asset growth will have to rely on stocks and a diversified portfolio of similarly risky assets such as venture capital, real estate, or private equity.

    A common rule regarding asset mix is that the percentage an individual should invest in bonds is equal to their current age. Although this allows for a gradual progression to living off interest income at retirement, there is little need for a 20-year-old, who has many decades to ride out stock market volatility in pursuit of real returns, to have even 20% invested in bonds.

    You Can Take It With You

    Even if you change jobs, the money youve contributed to your 401 and its earnings belong to you. Depending on your plan type, there are different ways to keep your retirement plan invested and growing on a tax-deferred basis. If youve left an employer, but still have an old 401 with them, find out what your options are for leaving it in plan or moving it somewhere else.

    Recommended Reading: Who Does Walmart Use For 401k

    Best Places For Employee Benefits

    SmartAssets interactive map highlights the counties across the country that are best for employee benefits. Zoom between states and the national map to see data points for each region, or look specifically at one of four factors driving our analysis: unemployment rate, percentage of residents contributing to retirement accounts, cost of living and percentage of the population with health insurance.

    Can I Retire At 62 With $400000 In 401k

    How Much Should I Have In My 401k?

    Shawn Plummer

    CEO, The Annuity Expert

    Can I Retire at 62 with $400,000 in a 401k? This guide will show you how to retire on $400,000, step-by-step. Well provide estimates on your retirement income at different age brackets.

    If you are close to transitioning to retirement, check our Retirement Planning Guide.

    If you are not close to transitioning to retirement, check out our Guaranteed Retirement Income Guide.

    Use an annuity calculator to get a better idea of the retirement income generated.

    This guide will answer the following questions:

    • Can I retire at 62?
    • How much do I need to retire at 62?
    • Should I buy an annuity with my 401k?
    • How long will $400k last in retirement?

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