Part of my FIRE portfolio includes investing in stocks. My dad showed me the power of stocks very early when I was 11 years old. He taught me how to read stock prices from the newspaper. It is where I first learned about all the strange acronyms such as P/E ratio (price to earnings ratio) and Div Yield (dividend yield). As a result of his teachings, I have always maxed my 401k contributions every year that I have worked since 2001. The sum of all the 401k limits between 2001 and 2020 is $319,000. With the power of compound interest and some luck, my lifetime 401k ROI sits around 144%. I expect to pass the pinnacle of $1,000,000 before 2025 when I turn 48 years old. FIRE is about making your money work for you and the 401k plan can help you get there.
What is the maximum 401k contribution for 2020?
I started working in June 2001 when the 401k limit was $10,500. In 2020, the 401k contribution limit was raised to $19,500 from the previous 2019 401k contribution limit of $19,000. I created the following chart below which shows the 401k Limits from 2001 through 2020. When you add the 401k Limit amounts together they equal $319,000 as seen from the 401k Max Total column.
My RTM 401k Balance as of 2020 is $569,088 where I am investing towards my goal of $1,000,000. This particular portfolio briefly touched $700,000 in January 2020 but was affected by the Coronavirus Pandemic market sell-off. In fact, this portfolio has been affected by 2 major events:
- Major Event 1: the Subprime Mortgage Crisis
- Major Event 2: the Coronavirus Pandemic.
I stopped contributing to this portfolio after I quit that job in May 2014 to attend graduate school. (I started a new 401k portfolio with my current job after graduating.) Between 2014 and 2020 this portfolio experienced a gain of 34% or $145,619. All of this money was made only from the power of compound interest and honest stock returns. FIRE is about making your money work for you.
What does 6% 401k employer match mean?
In addition to having health insurance, another advantage of Barista FIRE includes having a 401k employer match. Most employers that offer a match program usually offer between 3% to 6%. The employer match is calculated by multiplying the match percentage against your pre-tax salary.
- For example, pretend John Doe makes $100,000 pre-tax salary. His employer match program gives him 6% or $6,000.
- The rate at which his employer pays is $1.00 per $1.00 that John Doe contributes to his 401k until the match amount is met.
- If John Doe elects to make 14% contribution to his 401k, he would contribute $14,000 while his employer would match 6% or $6,000 for a total of $20,000 contributed to John’s 401k.
Wait, I thought the 401k contribution limit was $19,500 for 2020
The 401k contribution limit for 2020 is $19,500. So how did John Doe manage to contribute $20,000 into his 401k in 2020? The employer match does not count towards the employee 401k contribution limit. I think a lot of people fail to realize this very important fact. In my example, John Doe’s employer match of $6,000 is essentially free money. The rate of pay for the employer match now becomes an important factor. At $1.00 employer match, the payment rate would be $6,000 over 12 months or $500 per month.
How to maximize your 401k employer match
Let’s pretend John Doe is an aggressive investor and wants to reach his 401k contribution limit quickly. He sets aside 14% 30% of his $100,000 pre-tax salary. His contribution would be $30,000 over 12 months or $2,500 per month. His employer would match $6,000 over 12 months or $500 per month. A monthly contribution of $3,000 in total. After only 8 months, John would have reached $24,000 where his salary contributed $20,000 but capped at $19,500 towards his 401k. However, his employer match contribution amount only totals $4,000. Well short of the 6% or $6,000 employer match. Reaching the 401k contribution limit too soon meant John could no longer make contributions to his 401k, therefore, his employer would stop paying $500 per month match. Do not make this mistake of contributing to your 401k too aggressively!
John Doe should instead maximize the 401k employer match. John Doe should reduce his 401k contribution to 19.5% or $19,500 which perfectly matches the 401k contribution limit for 2020. His monthly contribution would be $1,625. Combined with his employer match of $500 per month would make $2,125 in total. After 12 months, John would reach $25,500 where his salary contributed $19,500 towards his 401k. However, this time his employer would have contributed the maximum employer match of $6,000.
What is a good percentage to put into 401k?
Each person will need to decide at what contribution amount he/she is comfortable making out of their paycheck. If you want to contribute the 401k limit, which I recommend, then you can apply a formula. The formula to find your max 401k contribution limit is to divide the 401k contribution limit by your salary. In my John Doe example,
- 401k contribution limit for 2020 is $19,500
- Salary of John Doe is $100,000
- Formula: $19,500 / $100,000 = 19.5%
What happens to your 401k when you leave a job?
How you leave your employer does not affect your 401k. So if you quit, were laid off, or were fired, it does not affect your 401k nor what you can do with it after you leave your job.
After you leave your job there are a few options that you can decide what is best for your 401k. Below is a list of options that are available for you:
- Rollover your 401k into a new account. If your new employer offers 401k, you can rollover your previous 401k into your new employer’s 401k or into a separate individual retirement account (IRA).
- Leave your 401k where it is. Many employers will allow you to leave it but you will likely not receive any investment services or financial advisor support because you are no longer an active employee for this employer.
- Retire and start taking distributions starting at age 59½ at the ordinary income tax rate. If you take any money out before 59½, expect to pay a 10% tax penalty for early withdrawal. Note that you must start making minimum withdrawals at age 72. Use this IRS worksheet to help you calculate the amount you must withdraw.
How much should I have in my 401k at 35 years old?
Every person will have a different number in terms of how much 401k savings a person should have at 35 years old. As you can imagine, retirement will heavily depend on retirement lifestyle choices. A person who lives inside a cabin in the woods and hunts for food will not need much money in retirement. A person who lives in the city of San Francisco will likely need much more money to afford $10 avocado toast and $7 lattes in the morning.
According to my chart above, I was age 35 in the year 2013 so my 401k balance was $366,900 by the end of the year. I was still working for the same employer but quit in September to attend graduate school for a couple of years. Between 2014 and 2020 this portfolio experienced a gain of 34% or $145,619. All of this money was made only from the power of compound interest and honest stock returns. FIRE is about making your money work for you and the 401k plan has certainly done that together with my real estate investments.
Below is a chart provided from Fidelity which provides some loose guidance on how much you should have saved at different ages.
What does your 401k balance look like today? How does it compare to the charts that I have shown from my 401k? Let me know in the comments.
