What Is Net Worth
Knowing your net worth is one of the most important aspects of personal finance. Its one of the best indicators we have to see if we are on target to meet our goals.
It is a powerful indicator of your financial health.
To calculate your net worth, simply subtract the total value of your debts from the total value of your assets.
To put it in layman terms:
Net worth = Assets Liabilities
If your assets are more than your liabilities, your net worth is positive. Congratulations, you are taking the first step towards retirement success.
If your assets are less than your liabilities, your net worth is negative. This is the time to take a serious look at your finances and see how you can best turn that negative net worth into a positive one.
How Much Should You Contribute To Your 401
Most people are advised to contribute at least 10% of their salary to a 401, but if you’re behind on savings, it’s a good idea to aim even higher. Currently, workers under 50 can contribute up to $18,000 tax-free to a 401. If you’re 50 or older, you get a catch-up provision that brings this limit up to $24,000.
If you can’t max out your contributions, you should at least make certain to kick in enough to take full advantage of your employer’s 401 match. Though 92% of companies offering a 401 give employees some sort of match, it’s estimated that 25% of workers don’t contribute enough to get their hands on that free money. All told, workers are leaving a good $24 billion in unclaimed matching dollars on the table every year. Ouch.
Another thing to keep in mind about your 401 is that the higher an average yearly return you’re able to generate, the less money you’ll need to contribute to reach your savings goals. Or, to put it another way, if you adopt an aggressive investment strategy, you’ll turn a relatively small amount of savings into a considerable sum over time.
The eventual value of your 401 will ultimately depend on how much you save each year, the number of years you save, and the return your investments generate. If you start early, invest wisely, and do your best to max out your employer’s matching contributions, you stand a good chance of amassing a sizable nest egg that will provide a healthy amount of income in retirement.
Retirement Savings In Your 40s
At age 40, you should have saved three times your annual salary, and this increases to 4Ã your income just about the time you hit that age that defines mid-life or âmidlife crisisâ.
Not to scare you, but if you are not yet saving at this point, you will need to double up. Investment timeframe is no longer your friend.
Continue to invest. Ensure you are not paying too much in investment fees. If you have a self-managed portfolio, ensure it is rebalanced at least 1-2 times each year.
A robo-advisor like Wealthsimple can save you the hassle of rebalancing and it offers free financial advice at a low cost.
You can compare robo-advisors in Canada.
Keep tabs on your emergency fund. It should hold 3-6 months worth of expenses and will need revisiting as your circumstances change.
Your 40s is a good time to increase your savings rate. Consider putting aside salary increases, bonuses, etc.
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Valuations For Streams Of Income
One of the challenges in calculating net worth occurs when you deal with assets that really represent a stream of cashflow like a pension plan. How do you account for these assets in your net worth calculation?
I talked to Rein Selles, one of Canadas most respected Professional Retirement Planners . Rein believes that the retirement planning industry largely ignores the value and importance of pension plans as an asset. Rein uses a simple rule of thumb when it comes to valuating a pension or a stream of cashflow,
For every $100 per month of income, you have an asset worth $18,000.
If you have a pension that pays you $3,000 per month, that pension is worth $540,000. If you get $800 per month from CPP, then that is worth $144,000. $500 per month from OAS is the equivalent of $90,000.
While this is a very simplistic approach it helps people to understand the value of pensions, government benefits and other streams of income.
You’d Be Surprised At How Much Your Savings Can Grow Over Time Here’s How To Estimate Your 401’s Eventual Value
The average Social Security check will only suffice in replacing about 40% of the typical worker’s pre-retirement income. Because most retirees will require 70% to 80% of their previous income to pay their senior living expenses, and some might need even more replacement income, relying on Social Security alone is a bad idea. Rather, you should aim to save independently for retirement, which means contributing to a 401 if your employer offers one.
The benefit of saving for retirement with a 401 is twofold. First, your contributions are made with pre-tax dollars, which means instant tax savings up front. Additionally, the money in your 401 gets to grow on a tax-deferred basis until retirement, which means you won’t pay capital gains taxes on your investments year after year. It’s this benefit, in fact, that allows countless savers to turn relatively small contributions into a much larger sum over time.
Knowing what your 401 will be worth in retirement can help you determine whether you’ll have enough income to pay your bills, or whether you’ll need to start saving more during your working years. Thankfully, we have a helpful tool for running the numbers and seeing how your savings stack up.
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When To Start Saving For A 401k
Not everyone gets the opportunity to invest in their 401k early on. As soon as it becomes available, consider taking advantage of this benefit. As of 2017, individuals under 49 could legally contribute $18,500 per year. Those 50 years or older, can save an additional $6,000 for a total annual $401k contribution of $24,500.
Many 20-something-year-olds have student debt, changed jobs a handful of times, have not started saving, or are not in a job where a 401k plan is offered. In this case, well look at the amount you should have saved starting at age 30.
A good rule of thumb is to add on one year of salary saved for every five years of age for example, at age 30 youd want to have saved one year of salary, at age 35, two years, at age 40, three years, and so on. Use these guidelines along with your post-retirement budget to gauge if you are on track for a comfortable retirement.
How Much Could Your 401 Grow If You Stop Contributing
Now lets examine what happens to your 401 when you stop contributing and your employer does not make any matching contributions either. Using most of the same parameters as before, lets use our 401 Growth Calculator to see how much your 401 will be worth if you stop contributing at age 30, after you have already accumulated $10,000 in your account:
- You are 30 years old right now.
- You have 37 years until you retire.
- You make $50,000/year and expect a 3% annual salary increase.
- Your current 401 balance is $10,000.
- You get paid biweekly.
- You expect your annual before-tax rate of return on your 401 to be 5%.
- Your employer match is 100% up to a maximum of 4%.
- Your current before-tax 401 plan contribution is now 0% per year.
What happens to your previous 401 balance of $795,517? It plummets to $63,485 $732,032 less than before. When you stop contributing to your 401 and have no employer matching contributions, your total 401 balance in year 37 is 92% less. Procrastinating with your retirement savings and your 401 contributions means you have to work much harder and save even more to catch up to where you need to be in order to reach your retirement goals. Learn more about the cost of waiting to save for your retirement.
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Spoiler Alert: Its Probably More Than You Think
Among Americans who contribute to a 401 or similar retirement plan, the most common contribution amount is just enough to take advantage of the employer match. For example, if an employer is willing to match its employees’ contributions dollar for dollar up to 5% of salary, the average worker will contribute 5% of their salary to take advantage.
While this is certainly a good start, you’re allowed to contribute a lot more to your 401 than your employer is likely willing to match. Here’s how much you could end up with if you decide to max out your 401 contributions in 2018, and every year after that.
What Is A Defined Contribution Plan
A defined contribution plan is any retirement plan to which an employee or employer regularly contributes some amount. Often, the employee chooses to send a fixed percentage of monthly income to the account, and these contributions are automatically withdrawn, directly from her paycheck – no effort required. The money that doesn’t go to the employee’s take-home pay gradually accumulates, the balance earns interest from investments, and by the time retirement rolls around, its grown into a substantial nest egg for the retiree. Thats the idea.
In a defined contribution plan , there are no guarantees about the income youll receive in retirement. That doesnt mean such plans cant be just as effective, however, and employers often sweeten the deal by making contributions of their own, straight into your account.
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Average 401k Balance At Age 45
When you hit your 50s, you become eligible to make larger contributions towards retirement accounts. These are called catch-up contributions. Make sure that you take advantage of them! Catch-up contributions are $6,500 in 2021. So if you contribute the annual limit of $19,500 plus your catch-up contribution of $6,500, thats a total of $26,000 tax-deferred dollars you could be saving towards your retirement.
Not A Math Whiz No Worries
You can find out how much your 401k will grow without the help of a financial wizard. Simply provide the required inputs variables and quickly calculator what your 401k will grow to in the future.
Play around with the actuals and the extras to model various what if scenarios to reach your financial goals. This Simple 401k Calculator can be your best tool for creating a secure retirement. The following step-by-step procedure will show you how
Calculating the compound interest growth and future value of your monthly contributions is as simple as entering your beginning balance, the combined contributions , an estimate of your return on investment, and the number of years until retirement.
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How To Get Retirement Ready
Open a retirement account. If you have access to a GRSP, you should at the very least contribute the amount of money your employer is willing to match. You should also open a RRSP if you dont already have one. A RRSP is one of the most popular ways to save for retirement in Canada and it comes with nice tax benefits. Learn more about RRSPs and GRSPs.
Avoid paying high fees. Fees are like savings termites theyll chew right through your savings. When you invest with Wealthsimple, we charge a 0.5% management fees when you invest up to $100,000 and 0.4% when you deposit more than $100,000. Thats significantly less than the 2% fees paid by traditional mutual fund investors in Canada.
Make smart moves. Begin saving for retirement as early as you can and take advantage of the power of compounding. Create a budget that includes retirement savings, learn how investing works, discover smart retirement strategies and understand what it takes to retire early.
Less Than 25 Years Old
- Average 401 balance: $6,718
- Median 401 balance: $2,240
- Contribution rate: 8.1%
Although many people younger than 25 years old are new to the workforce or are not in a job where a 401 plan is offered, their average 401 balance increased 23 percent in 2020 compared to 2019, and 49 percent of those who are eligible for a 401 plan are participating in it. This indicates that this generation is indeed planning for retirement early on.
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If You Want To Get The Most Out Of Your Employer Match You Have To Understand The Factors That Influence It
A 401 match is a flashy perk employers dangle in front of prospective employees, but its actual value varies quite a bit: anywhere from nothing to tens of thousands of dollars.
To find out how much you’ll get, you have to weigh several factors, which I outline below. Once you understand these basics, you can leverage this information to secure an even larger company match.
What Is The Difference Between Net Worth And Income
The United States tends to define wealth by income, not net worth. President Trumps tax plan, for example, says that middle-class couples earn between $75,000 and $225,000 whereas the Obama administration defined the middle class as households that make less than $250,000.
As you analyze and compare the average American net worth at retirement, its important to realize that income is not synonymous with worth. Its very possible for a retired household to have high net worth but low retirement income. They likely had higher income earlier in their life, which allowed them to build wealth and save for retirement.
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Your 401 Savings And Your Desired Retirement Lifestyle
How you want to live out your golden years is another huge factor in what your 401 savings will need to look like. Thats because retirement has evolved over time to become a more active time of life. Its now viewed as a new beginning to our lives rather than a beginning of our end. That shift in mindset has driven the need for additional sources of retirement income.
The Employee Benefit Research Institute study on the Expenditure Patterns of Older Americans shows that as we age our expenses decline. Using age 65 as a benchmark, the study found that household expenses drop by 19% by age of 75 and 34% by age 85. The study also found that people over the age of 50 spend 40-45% of their budget on their home and home-related items. The bottom line is that by the time we retire our expenses are down between 20% and 40%. This is why expert opinions differ on how much of our pre-retirement income we need. Guidelines generally vary from 60% to 80%.
If you have a household income of $100,000 when you retire and you use the 80% income benchmark as your goal, you will need $80,000 a year to maintain your lifestyle. Assuming your 401 savings grow at 8%, you should expect to have up to $80,000 a year in interest income so you can avoid having to touch your principal as much as possible.
How Is Wealth Distributed In Retirement
The detailed wealth table published by the Census Bureau shows how the population owns and distributes its assets. Take a look at the 65+ age range in the chart below, displaying data from 2015, to get a sense of how the average retirement savings are allocated.
Using this data set, we can categorize three main types of assets that comprise an individuals net worth: cash savings, retirement accounts, and home equity.
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Benefits Of Having A 401k
Different 401k plans come with different perks, each with unique advantages.
Tax advantages: Traditionally, the savings in your 401k account is pre-tax. This means that the amount you contribute is exempt from current federal income tax, which also lowers your taxable income. In this case, you dont have to pay tax on the funds until you actually withdraw them. Since most people are in a lower tax bracket during their retirement years, this may lower the amount they pay in taxes on 401k withdrawals. However, depending on the type of plan you have, the tax break can come when you contribute money or withdraw funds during retirement .
Employer matching contributions: In some cases, employers will offer to match the amount you put into your 401k, which is essentially free money! Employers might offer a certain percentage of what you contribute or even dollar-to-dollar matching. Consider saving up to the maximum annual contribution amount because employer contributions dont count towards your annual limit.
Lifetime contributions: In the case of some retirement accounts and IRAs, there is often an age limit for contributions. However, 401k accounts are not subject to this stipulation so you can contribute funds as long as you are working.
Automatic investment: For many, 401k plans may be the easiest way to save for the future because they automatically deduct funds from your paycheck and place them in the account. This way you dont have to think twice about your savings.
Retirement Savings In Your 50s
If you are a âFinancial Independence Retire Earlyâ adherent, your 50s could be when you retire .
For the average Canadian or American, a good gauge for assessing your retirement readiness is to have saved seven times your annual income by age 55.
If you havenât been investing or you have a huge shortfall, thereâs still hope, however, you will also need to start adjusting your expectations. For example, you could work a little longer and delay retirement by a few years.
Canadians can begin collecting CPP at age 65, however, for each year you delay it, your benefits increase by 8.4% per year until age 70.
If you decide to take CPP early at age 60, your benefits are reduced by 7.2% per year until you turn 65 .
At age 50 and above, you should be more careful with the investment risk you are taking.
For example, if your portfolio was weighed 80% stocks and 20% bonds, you may want to lower the risk level a bit by increasing the bond component and decreasing stocks e.g. 60% stocks : 40% bonds.
A more conservative portfolio may also be appropriate depending on your circumstances. This is because your investment timeframe is shorter and you have less time to wait for the markets to bounce back if there is a prolonged downturn.
Some other ways to boost your retirement savings include:
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