401k Calculator

401k Calculator

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401k Calculator


How do I calculate my 401k contribution?

Retirement planning is a too often neglected aspect of savings and personal finance.  In seeking out a 401k calculator, you have taken an important first step in securing your future by working with an employer on a retirement savings plan.  A 401k calculator can help you determine the appropriate amount to be paid into the 401k plan, which will provide for a stable and secure retirement.  Most importantly, money deposited into the 401k plan is not subject to income tax, which reduces the tax burden on that employee overall.

It is important to build a 401k account if you work for an employer that does not pay a pension, but will match contributions to a 401k plan.  The employer will have differing options for employees on a 401k plan, generally allowing for the funds to be invested in company stock or mutual funds.  In some cases, a trustee might direct the investment of the 401k funds, but this decision is usually left to the employee.

Bear in mind that funds in most 401k accounts are not meant to be withdrawn until the account holder is age 59 ½ and will be subject to penalties.  Additionally, tax is usually assessed on the money withdrawn from a 401k account.  It may be best to speak with a financial representative before deciding on early withdrawal.  Also, it is important to note that some 401k plans will have a “force out” provision for terminated employees with balances under $1,000.  The funds in the closing 401k must either rollover to an IRA or other 401k account, or will be cashed out by the account holder.

Why should I use a 401k calculator?

A 401k calculator will help you plan for impeding retirement by hitting a target you deem appropriate to keep you independent and maintain your standard of living in your old age.  With proper use of the 401k calculator, you can determine if your current contribution is sufficient by offering you a mathematical projection (while taking a few variables into consideration), and get a better understanding of how your money will grow over time, given a sufficient rate of return.  

The best 401k calculators will generate a report that shows the status of the account for every year.  For instance:

Year      Employee Salary  Employee Contribution   Employer Matching Contribution  Total Account Value

1 50,000.00 8,500.00   5,000.00 284,849.42

2 50,000.00 8,500.00   5,000.00 322,591.32

3 50,000.00 8,500.00   5,000.00 363,465.78

Short of speaking with a reputable financial advisor, you will not obtain a better picture of your retirement plans and potential retirement prospects while using a 401k calculator.  Especially when an individual turns 50 and is considering using the “50+ Catch Up” provision, the 401k calculator can help make that decision easier.

What are the terms used on the 401k calculator?

Annual Contribution Amount – this term reflects the amount the employee contributes to the plan yearly.  The 401k calculator assumes that the contribution will either remain a steady lump sum, or more likely, a steady percentage of the employee’s income, reflecting the potential for raises and other salary bumps.

Annual Salary – self-explanatory, this is your salary before taxes

Number of Years to Save- you must determine how many more years you intend to contribute to the account before you will begin to withdraw from it.

Current 401k Balance- you must enter the current balance in this box of the 401k calculator.

Catch-Up Contribution – this is an important provision, instituted in 2001 and made permanent in 2006, that allows those over age 50 to make additional payments into their 401k account in order to increase their retirement benefits when they retire.  The 401k calculator allows for catch-up contributions to be added to the calculation for a more accurate projection on how the account will grow.

Estimated Salary Increase Rate – here you must estimate a percentage of how your salary will grow over the defined period.  You may leave this blank or type “0” if you are unsure how your salary will grow.

Employer Contribution Match Rate – the employer may match funds contributed to the 401k account.  In this situation, the employee should almost certainly maintain a 401k account.  Any earnings from the 401k account will be tax deferred.  Enter 100 if all contributions are matched by the employer.

Maximum Percentage to Contribution – there will be a maximum limit of funds that you may contribute to the account.  Most calculators will express this as a percentage.  The typical percentage will be around 15% but you should check with your employer for the proper figure. 

Investment Rate of Return (%) – this is the anticipated rate of return on the investments made by the 401k.  This will be the greater factor that affects the growth of the 401k account.

How do I use the 401k calculator?

Using a 401k calculator is easy, as long as you gather all necessary information prior to beginning your calculation.  To use this 401k calculator, we will provide two examples.

Employee A contributes $4,000 out of a $40,000 salary annually and has done so for the past ten years.  The employee would like to determine the value of the 401k account in 20 years.  The employee’s company matches A’s contribution at 50% making the total value of his 401k account $60,000.  This matching relationship will continue for the foreseeable future.

The employee is not constrained by a maximum percentage to contribution and estimates that his salary will rise 5% in the next 20 years.  To compensate for the higher earning potential, the employee intends to save 10% of his annual salary through the 401k.  Since the employee is not yet over the age of 50, he cannot employ the catch up provision to increase his benefits.  The rate of return is predicted to be 8%.

We enter the following information in the 401k calculator:

Annual contribution – 4,000

Annual salary - 40,000

Number of years to save – 20

Catch up – 0

Current 401k balance – 60,000

Estimated salary increase rate – 20

Employer contribution rate – 50

Maximum Percentage to Contribution - 100

Investment Rate of Return – 8

After entering these numbers into the 401k calculator, we determine that the value of this plan in 20 years will be $727,336.89.  A substantial sum, yet the employee will not have even turned 50 yet.  The employer match provision proved to be very useful as well, contributing nearly $100,000 to the 401k account.  All of this assumes though, that by year 20, the employee is making over $100,000 annually and contributing 10% of that.  This is possible but not the average scenario for most Americans with a 401k plan.  

For a more typical use of the 401k calculator, let’s consider employee B who has just turned 50, plans to retire in 10 years, has contributed modestly to her 401k and would like to increase her retirement benefits.

Employee B works for $50,000 and contributes 10% of her annual income to the 401k.  She intends to add the maximum $3,500 toward the Catch Up provision.  The catch up provision is tacked on annually, on top of the 20% contribution.  The current value of the account is $250,000, with an investment return rate of 8%.  The employee does not expect her salary to rise in the next ten years.  The employer will match contributions made by employees over 50 and 100%.

Let’s plug in these numbers to the 401k calculator to determine if employee B may retire.

Annual contribution – 5,000

Annual salary - 50,000

Number of years to save – 10

Catch up – 3,500

Current 401k balance – 60,000

Estimated salary increase rate – 20

Employer contribution rate – 50

Maximum Percentage to Contribution - 100

Investment Rate of Return – 8

Luckily, for Employee B, this plan for retirement will value her 401k plan at $762,096.44 when she is ready to retire in ten years.  This number will be even better if she contributes an even larger share of her annual salary to the account.  Her account could be valued as high as 1,898,76.31 if she would to continue working for an additional ten years, retiring at 70, but it’s not often that an employee will be willing to work that long.  In this case, the 401k calculator has helped employee B determine that her retirement is in reach, so long as she remains consistent to her plan and continues to use the Catch Up provision.  Without the Catch-Up provision, Employee B would only net $708,381.45 and the money that she did not put into the account will be taxed, as per normal.

This should demonstrate how useful a 401k calculator should be in terms of planning for retirement or deciding on the amount to save, annually for retirement.  As with all financial calculators you find on the internet, a 401k calculator should not be used in lieu of a financial adviser.

You should use the 401k calculator to have a guideline before speaking with HR department of your organization.  Never enter personal information or information that may compromise your identity into these programs and never pay to use or see the results from a 401k calculator.

 

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