Almost anyone can become a millionaire if they make a commitment to save early in their career and stick with it over several decades. Savvy investors will be helped along by employer contributions and tax breaks and will avoid high fees that reduce investment returns. Here's how to save $1 million in time for retirement.
Start saving at an early age.
Putting money away for the future beginning at a young age makes it much easier to become a millionaire by the time you retire. If you start saving for retirement at age 25 and save $4,830 per year, or about $400 per month, and earn 7% annual investment returns, you will accumulate just over $1 million by age 65. Compound interest does much of the work for you. If you wait until age 35 to start saving, you'll need to save over $10,000 per year to hit $1 million by 65, assuming the same investment returns.
Become a super saver.
An empty nest gives you an opportunity to focus on filling up your retirement accounts. It takes some serious saving to become a millionaire in the years leading up to retirement, but it's not impossible, especially if you have worked your way up to a job with a high salary. A worker who saves a little over $36,000 per year between ages 50 and 65 and earns a 7% annual return that is compounded monthly will achieve millionaire status by retirement. Remember to take advantage of catch-up contributions to retirement accounts, which allows people age 50 and older to put an extra $6,500 in a 401(k) and $1,000 in an IRA.
Capture employer contributions.
Make sure you deposit enough money in the 401(k) plan to qualify for any matching funds your employer provides. If you qualify for a 401(k) match, you can get by saving a little less and still hit $1 million by retirement. A worker who starts saving at age 25 and gets a $1,500 annual match could save $1 million by age 65 by tucking away as little as $3,330 per year. A worker who starts saving at 35 and gets the same match would need to tuck away $8,705 annually to hit $1 million by retirement.
Vest in your retirement accounts.
You don't always get to keep employer contributions to your 401(k) plan when you leave a job. Many companies have vesting schedules that prohibit departing employees from taking a 401(k) match with them until they work for the firm for a specific number of years. Some employers allow workers who leave the company to keep only a portion of the 401(k) match based on their years of service. Job changers need to be careful in order to keep employer contributions. When making career decisions, remember to factor in any retirement savings you might be leaving behind and make sure the new opportunity is worth it.
Save money on taxes.
You can use retirement savings tax breaks to grow your money faster. If you put $5,000 in a 401(k) and you are in the 24% tax bracket, you will save $1,200 on your tax bill. Traditional retirement accounts can be especially beneficial to people who currently pay a high tax rate. For example, if you are a high earner who pays a 32% income tax rate, you could reduce your income tax bill by $1,600 if you put $5,000 in a 401(k). Income tax won't be due on your contribution until you withdraw it from the account. If you drop into a lower tax bracket in retirement after you stop working, you might be able to pay a lower tax rate on your retirement savings.
Watch out for taxes in retirement.
You don't get to spend all the money you have saved in a traditional 401(k) plan or IRA because you have not yet paid taxes on that money. Distributions from traditional retirement accounts are considered income and you will owe income tax on each withdrawal in the year you take the distribution. It's important to note that you will need to accumulate more than $1 million in a traditional retirement account to have a million dollars to spend in retirement because of the income tax due on each distribution. But if you save $1 million in an after-tax Roth IRA, no income tax is typically due on distributions in retirement.
Avoid high-cost funds.
Investment fees are deducted from your retirement and investment accounts, which reduces the growth in your account over time. Your investments will grow faster if you minimize the fees that are deducted from your returns. If you save for 40 years between ages 25 and 65, but a 1% annual fee reduces your returns from 7% to 6%, you will need to save about $6,260 per year to reach $1 million by retirement, instead of $4,830 per year without the extra 1% fee. Take care to seek investments with low expense ratios.
Watch out for penalties.
Don't let retirement account penalties reduce your retirement savings. Watch out for 401(k) and IRA penalties if you take money out of your retirement accounts too soon or too late. There's a 10% early withdrawal penalty if you take a traditional IRA distribution before age 59 1/2 and a 50% penalty if you fail to start taking traditional IRA withdrawals after age 72. If you need access to your retirement savings sooner, find out if you qualify for one of the exceptions to the early withdrawal penalty. Also, watch out for taxes and penalties when rolling money over from a 401(k) to an IRA or new 401(k) when you change jobs.
Don't plan on a lavish retirement.
While becoming a millionaire seems like a worthy retirement goal, the money is only likely to produce a modest retirement income when spread over several decades of retirement. If you draw down 4% of $1 million in savings per year, this nest egg will generate about $40,000 of annual retirement income. When combined with Social Security income, $1 million in savings could produce a comfortable retirement lifestyle in some parts of the country, but in high-cost cities, it might not be enough.
How to save $1 million by retirement:
— Start saving at an early age.
— Become a super saver.
— Capture employer contributions.
— Vest in your retirement accounts.
— Save money on taxes.
— Watch out for taxes in retirement.
— Avoid high-cost funds.
— Watch out for penalties.
— Don't plan on a lavish retirement.