How Does a 401K Work? [How to Get a 50% Return]

Updated : Aug 28, 2019 in Articles

How Does a 401K Work? [How to Get a 50% Return]


Americans are missing out on $24 billion in
free retirement savings each year. Your piece of that could be as high as $250,000
if you don’t know exactly how a 401k works and how to take advantage of it. In this video, I’ll show you how a 401k
plan works, the average balance by age and how to get the most out of your plan. I’ll also reveal why I hate these plans
but why you should invest anyway. We’re talking 401k investments today on
Let’s Talk Money! Beat debt. Make money. Make your money work for you. Creating the financial future you deserve. Let’s Talk Money. Joseph Hogue with the Let’s Talk Money channel
here on YouTube. I want to send a special shout out to everyone
in the community, thank you for taking a little of your time to be here today. If you’re not part of the community yet,
just click that little red subscribe button. It’s free and you’ll never miss an episode. We have got a retirement crisis in America! Nearly half of all retirees depend on social
security, about a thousand dollars a month. Worse though is that investors are passing
up free money and the best return you’ll ever make. A new study found that one-in-four Americans
aren’t maxing out their company’s 401k match, missing out on $1,336 a year. That’s free money and at the market rate
of return, it’s costing you over $250,000 over 35 years. More than $24 billion of this free money is
missed every year with younger people missing more. One-in-three workers between 25 and 30 are
missing out on this free money. I get it though. When you’re barely making enough as it is,
you’re not thinking about maxing out your 401k plan and there’s a lot of confusion
around what these plans really do. We’re changing that in this video. I’ll show you how a 401k works and why it’s
by far the best investment you’ll ever make. I’ll show you the average 401k balance by
age and how much to put into your plan. I’ll also reveal why I secretly hate 401k
plans but why you should invest anyway. As an informal survey of the community though,
I want to get your input here. Do you have a 401k plan at work and what is
your company match? Does your 401k match dollar for dollar or
50%? Scroll down and tell us in the comments and
we’ll show the results in a future video. A 401k is a special retirement investing account
set up by your employer with a plan administrator, usually an investment company. The plan includes a list of stock and bond
funds in which you can invest. You set up how much you want to invest regularly
and that money comes out of your check before taxes are taken out. Besides that pre-tax benefit, most companies
will match a portion of your investment. So a typical company match is your employer
will put in another half of what you put in up to 6% of your total salary. These are two huge benefits of a 401K plan,
that tax benefit and company match. So breaking this down. Your 401k plan is a special benefit set up
by your company. You decide how much you want to put in from
your paycheck and the company matches some of that, giving you free money rewarding you
for saving. Your money goes into an account you own, managed
by an investment company so totally separate from your employer. Plus…PLUS! You don’t have to pay taxes on the money
you put into your account until you take it out in retirement! Now there’s a catch to how much free money
your employer is going to give you. Most companies cap this at 6% of your salary. So if you save 6% of your salary for retirement,
your company will match it or put in half depending on the program. Think about that. If you make $30,000 a year, you only need
to put in $1,800 a year, that’s 6% so about $150 a month, and your company is going to
give you an extra $900 a month to retire on. That $150 a month on your part plus the company
match is going to grow to over half a million dollars over 35 years and provide an extra
$23,000 a year in retirement. There’s one more thing you need to know
about your 401k plan before we look at those average balances by age and a strategy to
take advantage of all this. Your company will have a vesting schedule
which is how much and when you get to keep the money your company puts in the account
for you as a match. I know, it sucks that you don’t get to keep
all your company’s match immediately. You’ll always keep everything you put into
your account but the company’s match is yours gradually. It’s just a way for the company to keep
people around longer. For example, we see the vesting schedule for
workers at Sprint here. So if you are a Sprint worker and contributing
to your 401K account, the company matches half of your investment up to 4% of your salary. If you make $40,000 a year, the company will
match 50% of your contributions up to $1,600 so they’ll put in another $800 a year. Sprint will put its match amount in every
time you invest but according to this schedule, if you leave the company after a year then
you only keep 33% or a third of what they put in. If you work two years and leave then you keep
two-thirds or 66% of what the company put in. This is actually a really nice vesting schedule. When I was an economist for the State of Iowa,
the 401K vesting spread out over decades so it took much longer to keep all the employer
match. Here we see average 401k balances by age and
this is data from Fidelity. So Americans in their 30s have an average
of $38,000 saved in their 401k plan. By the time you get to retirement, so that
age range between 60 and 69, the average American has just under $170,000 in a 401k. These red lines and the numbers on the right
are what Fidelity recommends you have saved by that time and this is in number of times
your salary. So by your 30s, they recommend having about
two-times your annual salary saved. That recommendation increases to 9-times your
salary by the time you retire so for example, if you make $36,000 a year then Fidelity says
you should have about $324,000 in your 401k plan by the time you retire. There is obviously a huge gap in that recommendation
and what people actually have saved for retirement. That $168,000 average 401k balance is only
enough to provide about $560 a month if you’re taking out 4% a year. Basically, the average retiree here is looking
at running out of money in less than 10 years. Of course, this is the average of people that
have anything saved in their 401k program. This doesn’t even include the 48 million
Americans with nothing saved at all, that’s three-in-ten people that will rely completely
on about a thousand a month from social security to live on. But this is a problem that is so easy to fix. Having that company 401k match means you only
need to contribute a small part of your check to be ready for retirement. Going back to our example, if you’re contributing
just $150 a month and getting a half match, then you’re set for a half million dollar
payday in retirement. Even contributing half that, so just $75 a
month and getting your company match, means having over $250,000 by the time you reach
65. But I want you to try maxing out your company
match, that’s the real secret to 401k plans. This means finding out your company’s match
rules. If they offer to match up to 6% of your salary,
then contribute 6% of your salary. If they only match up to 3% then at least
contribute that much. You can take it out of each check, just one
check a month or even take the whole year’s contribution out all at once. Now I want to talk about 401k loans pros and
cons and why I have a love-hate relationship with 401k plans. If you’re likin’ the video though and
the information, do me a favor and tap that thumbs up button below. I see a lot of people fall for the 401k loan
trap and it can seem like a way to get a cheap loan. How a 401k loan works is you borrow from the
account value, basically taking that amount out of your savings. You usually have five years to repay the loan
and everything you repay, interest and all, goes back into your 401k account. So basically you’re paying yourself the
interest. That might seem like an interest-free loan
and a good way to get a little extra cash but there are some big downsides to a 401k
loan. The downsides to a 401k loan are that you’re
missing out on a lot of returns and company match while you repay the loan. Your money is not longer invested so the only
return is that interest you pay and most plans won’t let you contribute while you pay back
your loan. That means no company match either. Even worse, if you leave your job and can’t
repay the loan, you’ll owe a 10% penalty and the taxes on the amount. So the simple answer is don’t borrow on
your 401k account. Now after all this, after telling you why
a 401k plan is such a great deal and how you absolutely must be contributing to your plan,
I want to tell you why I hate these programs. And the reason here is that 401k plans are
so damn expensive! The average 401k plan charges you 1% on your
money each year just to run the plan. On top of that, you pay a fee for each fund
you hold in your plan, an expense ratio that can average another 1% on the mutual funds. And while I love exchange traded funds, those
ETFs that trade like stocks and charge ridiculously low fees, most 401k plans only allow you to
invest in mutual funds provided by the investment company. Those mutual funds are typically five-times
more expensive than an ETF alternative. Forbes found in one study that a difference
of just 0.93%, less than one percent difference in fees, can cost a single investor up to
$215,000 in their retirement. Now the tragedy here is you really can’t
do much about it. Your company sets up the plan with the investment
company and the fees are set. I still want you to max out your company match
because that’s free money, even despite those higher fees. Getting a 50% match on your contributions
is like an instant 50% return. That’s the kind of return that would make
even Warren Buffett salivate so don’t miss out on the benefits of a 401k. I’m linking here to a new dividend portfolio
I just created, if you want your dividend stocks to pay your bills, click on the video
to the right. Seven dividend stocks that will put cash in
your pocket every single month. Don’t forget to join the Let’s Talk Money
community by tapping that subscribe button and clicking the bell.

37 Comments

  • A very important thing that we are not taught to become financially independent! Start as soon as possible and invest no matter what 🙌

  • We get a Roth & traditional 401k plan with a 100% match up to 6%. I contribute 6% in my roth since my employer match goes into my traditional. We also get a bonus of 1% our previous years salary as profit share program in an annual contribution to our traditional 401k.

  • I have a 457 plan that I contribute to along with a cash match plan 401a. If employees put in $150 a pay period which is twice a month, our employer will match $100 which is the max they will contribute. That is a 67% return of FREE money. I do and have been taking advantage of this for lot of years.

  • Great topic! Question: I have several 401k's from the different companies I have worked for over the years and I am not contributing to them anymore. Should I keep them where they are? Can I roll them into all one plan? Should I pull the money out and invest it elsewhere? I know you said you should never borrow on them but if I can get better returns elsewhere should I just pay the penalties and take a different route? Love your videos and thanks for all the hard work!

  • I contributed to the TSP when I was in the Army. Now I hear they will provide some % for matching over a retirement after 20 years of service.

  • My current company does a 50% match up to 6%. I was maxing out my 401k contribution limit until I did some number crunching. Then I scaled back my contributions to 6% to get the full employer match and put the remaining contribution amount into a Roth IRA.

  • So the bottom line is to put the maximum into the plan that your company will match ( free money ) then after that put as much as possible in a self-directed IRA in a brokerage account.

  • Since I just started a business last year I don’t have a 401k myself (use brokerage account & Roth IRA) but my spouse does. No company match, they contribute 10% of salary yearly regardless of whether someone contributes (fully vested as soon as it is deposited). For this year we still contribute 10% to help decrease taxable income in order to contribute to Roth but after this year we will contribute to Roth via the backdoor because I would rather have more control over my investments than putting them in the company 401k.

  • I have always contributed to get the maximum amount my employer will give to me per pay period. Get the FREE money first, then contribute to the limit with my ROTH .

  • My company doesn't match, but puts in a part of their profit in one lump sum payment. Payout has been quite good at more than 10% over last 10 years. I still contribute 5% (planning to increase to 20% when the market starts retreating) since it's a Roth account and I like the tax free part of it. I also maximimze my Roth IRA.

  • Aha that makes sense, so that’s why 401K’s are so mysterious to even proficient retail investor.
    Can you elaborate on why target date mutual funds are very popular but no one knows what is in it? I did some online research but this is beyond my comprehension because I wanted to set up my own 401K plan but FedEx restricts my access to funds (must be a way to save on the cost). I reallocated my funds to 60% stock, 28% bonds and 12% short term investments (commercial notes, money market funds, securities mature less than a year and cash reserves funds).
    I work part time so I can’t contribute much in my 401K plan but when I graduate university in a year or so I’ll hope to work in real estate appraisals and match 5% if they offer an employer match.

  • Joesph, loved this video and would love to see you put out more content on this! The company I work for matches @ the average 6% that you spoke about in the video. The first 1% dollar for dollar, the next 5% is 50% to the dollar. I'm currently a government contractor and I've heard contracting companies that will pay 10% regardless if you match or not (no I promise I'm not making this up)! My question to you is every 401K program has an investment bank or firm running all the employees accounts (mine is currently Fidelity). Which firms or banks out there have the best reputation for their 401k programs and which don't?

  • Love the channel Joseph. I'm playing catch up. I max out a Roth ira. Should I max out my 401k with no match or invest in an after tax account. Turning 50 next year.

  • I have an "ask an accountant" question. My company doesn't match, but they have a profit sharing program that actually paid out quite a bit both of the two years I've been with them so far. You are only fully vested in those contributions after being there for five years though. Are they paying less taxes on the earnings that they put into our retirement funds? And what happens to the unvested balance when people leave the company before the five year mark? If they've already reported that profit in a previous year what exactly do they do with it once it's returned to the company? We seem to have a very high turnover rate and I suspect that it's that way by design. Does any of this sound sketchy to you?

  • Thank u for the video and all the videos!
    My job matches up to 3% it will pay up to 4 1/2% if you put in 5%
    Im 41 and currently do not have one but I started investing in stocks do you think it's worth it for me to put in 5% or 3%? Thanks a lot!

  • I think you might be making too much of generalization on the fees. I’ve worked at both large and small companies and what you’re describing is far more likely in small companies. The two large companies I worked for fees were cheap…less than .2% for index funds. You also have the option to open up a self-directed 401(k) brokerage account where you can invest in any stock. For that I pay $125 a year and $7 a trade. Not bad considering I have a significant amount of money in the self-directed account.

  • For my pension if I pay 2% of my salary my employer pays 3% which is excellent, apart from the %'s being so low. After that 3% contribution that's it for free money. We also have a higher and lower tax band in Ireland and I'm just over in the higher band, so it makes sense to pay the amount it takes to bring me back into the lower band tax free as well.

  • I take advantage of Disney’s 4% match for me and contribute 18% per paycheck right now. I’m thinking of creating my own ROTH IRA on M1 and making a portfolio of REITs and solid dividend companies and doing the 6K max per year moving forward, taking 6K less from my 401K. Could this be beneficial to me if I choose good companies for the ROTH?

  • Great video Joe! 😀 I’ve seen people talk about how you’ve got to contribute to your 401k to ensure you get the match because it’s FREE MONEY, but I’ve never thought to phrase that as part of your return. GREAT JOB!

  • My employer does not match, however they do contribute an amount equal to 10% of the employee's salary on their own regardless of whether or not the employee contributes. 4 year vesting period.

  • My company contributes 3% of salary then matches half of the first 5% you contribute. We are able to make pre-tax contribution % and Roth (after tax) contribution %.

  • Great Video! My company matches 7% to my 5% with Voya. Anything beyond that, should I put in my Vanguard Funds?

  • My employer (large medical device manufacturer) matches 6% dollar for dollar. They also offer a Roth 401(k) which I put my contributions towards (employer match dollars go in pre-tax). They also charge us very little in fees and go through Vanguard so plenty of great investing options. All in all, it's a very good retirement plan.

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