Is this $ 136,852 gift hidden in your 401 (k)? – The crazy fool


I have news for you: your 401 (k) could have a huge advantage buried in the fine print. And no, it's not your business. (But if you have one, take advantage of it, it's free money for retirement!)

This gift of $ 136,582 has a boring name – self-escalation – but offers you a great opportunity to expand your retirement wealth, provided you have enough time.

The psychology of saving

One of the main advantages of 401 (k) is that it makes you forget that money exists. Oh, of course, you get a quarterly statement, but the money is not in your checking account (where it could be spent) or in your brokerage account (where you might worry about volatility and start to try to synchronize the market). You get used to a salary slightly lower than you would otherwise, and the savings are easy.

That's a good thing because it takes a status quo bias – our inherent tendency to do nothing – and makes it a savings advantage. After all, reducing your carryover percentage by 401 (k) requires effort, efforts that could be spent on the millions of other activities that are currently attracting your attention. As a result, many people report a percentage of their salary in their 401 (k) and forget about it.

Here is where self-escalation comes in. It usually works like this: you start your 401 (k) plan by withholding 6% of your salary in the first year. The plan automatically gets you up to 7% next year. And 8% the next year. And this continues until you touch, for example, 10% of each pay check. Every year it's a minor difference, something that's easily missed when you get a cost-of-living adjustment.

Automatic climbing gives you an excellent opportunity to do nothing and save more. This is becoming more common: according to a study by Willis Towers Watson in 2018, 60% of 401 (k) plans now offer automatic escalation.

Pot of coins on a sign with

Source of the image: Getty Images.

Let's work the maths

Imagine that you are earning the median household income in the United States – this represents $ 61,372 as of 2017 (the most recent year with full data), according to the US Census Bureau. Visualize that you never receive an increase, that your 401 (k) does not match and that you save 6% of your salary each year for 30 years with an annual return of 7% (fairly standard for the stock market ). , historically speaking). After 30 years, your nest egg is worth $ 372,183. Not a big chunk of change!

Now, compare that to the same scenario – except that you have the chance to incorporate automatic escalation into your 401 (k), so the 6% savings in the first year become 7% the second year and increase by one percentage point. each year until it reaches 10% in the fifth year and then stays flat. Now your savings are $ 576,545, which is more than the $ 500,000 that the median worker thinks is needed in retirement. (I think that number is way too low – but it's his own conversation for another day.)

Now, when you look at these two numbers ($ 372,183 and $ 576,545), you notice that there is more than $ 200,000 separating them. Part of this comes from additional contributions from savings made each year on your 401 (k) (10% versus 6% in the sixth year, for example). But most of it is due to the composition of these additional savings.

Total change in account value $ 204,362
Less additional contributions ($ 67,509)
Total difference in yields due to composition $ 136,853

Source: Author's calculations.

The gift of automatic registration could be worth an additional $ 136,853 in return. Of course, your mileage may vary – it's impossible to predict stock market returns in the future (as we all would like). And you would probably be different from the average American household (hopefully more!). Also remember that this exercise took for granted our mythical worker never received an increase.

And here is the best part

Your employer may not offer an automatic escalation feature, but you can create your own automatic escalation plan. Just put a date in your calendar and leave yourself a reminder to increase your contribution 401 (k) by one percentage point that day. Block 20 minutes to talk to HR and fill out the paperwork – in general, it's pretty simple – and you can then go back to forgetting your 401 (k) for the next year.

(Plus, you can eventually increase beyond 10% if you are so inclined. It's where things get really interesting.)

Given the scale of the benefit, if you can afford to increase your carry-over each year, or even every other year, it's a great opportunity to grow your retirement nest egg. This, added to a long track, allows you to take advantage of the best allies of retirement savers: time and capitalization.

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