For the vast majority of workers, a 401(k) plan may be the only retirement plan offered by employers. If you won't receive a traditional pension benefit from your employer, will a 401(k) plan be enough to fund your retirement?
Answering that question is difficult because the 401(k) plan has only been around for 20 years, so no current retirees have saved in a 401(k) plan for their entire working career. However, the Employee Benefit Research Institute (EBRI) conducted a study to determine what percentage of income a typical worker investing in a typical 401(k) plan for his/her entire working career could expect that 401(k) plan to replace. Assuming investment returns similar to the period from 1929 to 1978 and an average contribution rate of 9.3%, the EBRI estimated that a worker could replace 72% of his/her income with a 401(k) plan and Social Security benefits. That assumes that the worker is consistently covered by and contributing to a 401(k) plan from his/her late 20s until retirement at age 65 (Source: Can 401(k) Accumulations Generate Significant Income for Future Retirees?, November 2002).
But how realistic are those assumptions? The statistics are not very encouraging (Source: Money Central, 2005):
- Approximately 25% of workers don't participate in their 401(k) plan.
- Only 10% of workers contribute the maximum amount permitted.
- Almost half of those who do participate don't contribute enough to receive the full match from their employer.
- Participants make a variety of mistakes when investing their 401(k) funds, including investing too conservatively, not rebalancing on a periodic basis, and investing too much in their company's stock.
- Almost half of those changing jobs cash out their 401(k) account rather than rolling it over to another 401(k) plan or an individual retirement account.
And remember, the EBRI's study concluded that a 401(k) plan and Social Security would replace 72% of income. With increasingly active retirement lifestyles, it is often estimated that a new retiree will need 100% or more of pre-retirement income to fund their retirement lifestyle.
So what can you do to take full advantage of your 401(k) plan? Participate as soon as possible. Contribute the maximum amount permitted. Make sure to take advantage of all company matching contributions. Invest in options appropriate for the long-term nature of your goals. Rebalance at least annually. Don't borrow from your 401(k) plan. Never cash out a 401(k) plan balance, no matter how small, before you retire. Get those basics right and you'll go a long way toward ensuring your 401(k) plan will provide significant retirement income for you.