401K Calculator Instructions
To use this calculator effectively, please provide the following information:
- Contribution Percentage: Specify the percentage of your salary you contribute to your 401(k) each year. This will help us calculate your annual contributions.
- Annual Salary: Input your current annual salary. This information will be used to estimate your future contributions to your 401(k) based on a percentage you specify.
- Expected Annual Salary Increase: Provide the estimated annual increase in your salary percentage-wise. This factor will be considered when projecting your future contributions.
- Current Age: Enter your current age in years. This will help us determine the number of years you have until retirement.
- Desired Retirement Age: Specify the age at which you plan to retire. This information will allow us to calculate the number of years you have to accumulate retirement savings.
- Current 401(k) Balance: Enter the current balance of your 401(k) account. If you don’t have one yet, you can enter “0” to start from scratch.
- Expected Annual Investment Return: Enter the expected average annual return on your 401(k) investments. This information will help us estimate the growth of your savings over time.
- Employer Matching: If your employer offers a matching program, enter the percentage of your salary that your employer contributes to your 401(k). If there is no matching program, enter “0”.
- Employer Matching Limit: This is usually a cap or limit that your employer set for annual matching. Notice it’s also applied to each pay period. Many participants overlook this per pay period limit and might end up getting much less match from their employers if they contribute too much for each period and hit the annual contribution limit before year end.
Results: Based on the information you provide, our calculator will generate a table with each row showing the account balance for an age.
Understanding 401(k) Retirement Savings Plans
What is a 401(k)? A 401(k) is a retirement savings plan available in the United States that provides tax benefits and is typically offered through employers. It gets its name from subsection 401(k) in the Internal Revenue Code, which was established by the Revenue Act of 1978. While most 401(k) plans are employer-sponsored, self-directed 401(k) plans exist for individuals who cannot participate in employer-provided plans.
Contributions and Tax Benefits Contributions to a 401(k) are made from pre-tax deductions in your paycheck, meaning the money is taken out before taxes are applied. The dividends, interest, and capital gains within the 401(k) grow tax-deferred, which implies that taxes on these earnings are postponed until a later point, generally during retirement. As an employee, you can contribute a percentage of your pre-tax salary to your 401(k) account, subject to limits set by the IRS. Employers may also set their own limits on employee contributions.
Advantages of a 401(k)
- Tax-deferred growth: The earnings on a 401(k) are not immediately taxed, allowing your investments to potentially grow more quickly over time.
- Employer matching: Many employers offer matching contributions to employees’ 401(k) plans, which boosts your retirement savings.
- Tax-deductible contributions: Contributions made to a traditional 401(k) plan, both from employees and employers, are tax-deductible, reducing your taxable income and total taxes owed.
- High contribution limits: 401(k) plans have high annual contribution limits, allowing you to save more for retirement compared to other retirement accounts like IRAs.
- Creditor protection: 401(k) funds are generally protected from bankruptcy, providing a level of financial security.
Considerations and Potential Drawbacks
- Limited investment options: 401(k) plans often provide a limited selection of investment options determined by the employer, which may restrict your ability to invest in specific assets.
- High fees: 401(k) plans can have higher fees due to administrative costs. Participants can choose low-cost index funds or ETFs to minimize fees.
- Liquidity limitations: Generally, you cannot withdraw funds from a 401(k) without penalty until you reach 59 ½ years of age. Exceptions are rare and primarily include financial hardship situations.
- Vesting periods: Employers may impose vesting periods, meaning that employer contributions do not fully belong to employees until a specific period of time has passed.
- Waiting periods: Some employers require a waiting period before employees can participate in their 401(k) plans.
401(k) Investments
Investment Options In general, most 401(k) offerings allow individuals to invest in a variety of portfolios, such as mutual funds, index funds, or ETFs. These portfolios typically consist of a mix of stocks, bonds, international market equities, treasuries, and other assets. Automated portfolios like target retirement funds that adjust risk exposure based on projected retirement age are also common. Some plans allow for active individual stock investing, though this is less common.
Employer Match A 401(k) match is an employer’s percentage match of a participating employee’s contribution to their 401(k) plan, usually up to a certain limit denoted as a percentage of the employee’s salary. Employer matches are provided to attract and retain talented employees and incentivize saving for retirement. Taking full advantage of an employer’s match by contributing to a 401(k) can generate an immediate return on investment that is hard to beat.
Contribution Limits and Taxation Annual contributions to an employee’s 401(k) account cannot exceed the lesser of 100% of the participant’s compensation or $66,000 in 2023. Both employee and employer contributions are made untaxed and the funds grow tax-free over time. When you withdraw funds from your 401(k) during retirement, they will be taxed. However, retired individuals are often in lower tax brackets than they were during their working years, which can result in tax advantages.
Defined Contribution vs. Defined Benefit Plans A 401(k) is a type of defined contribution plan, which differs from a defined benefit plan (DBP) or pension plan. In a defined contribution plan like a 401(k), individuals have the flexibility to choose from various investment options and the value of the retirement account depends on contributions and investment performance. On the other hand, a defined benefit plan provides a predetermined benefit based on formulas considering factors such as salary, years of service, and age.
The popularity of defined contribution plans like the 401(k) has increased compared to defined benefit plans due to factors such as higher workforce turnover and greater flexibility in managing retirement savings. Unlike DBPs, 401(k) accounts can be easily transferred when changing jobs, providing more mobility and control over retirement funds.