It can be satisfying to watch your 401(k) plan balance grow over time as you contribute to it. But what happens when those contributions stop? The amount your account will grow depends on how much money you have in it and how the market performs. Here is how you can estimate the future performance of your 401(k). If you’d like personalized advice about planning for retirement, consider working with a financial advisor.
What Is a 401(k)?
A 401(k) is an employer-sponsored retirement account that offers tax benefits. A traditional 401(k) will be withdrawn from your paycheck pretax and will only be taxed when you withdraw from it in retirement. A Roth 401(k) is similar but reversed, in that the money that goes into it is already taxed, so it won’t be taxed when you withdraw from it in retirement. You can withdraw from either type of 401(k) penalty-free beginning at age 59 ½.
When you sign up for a 401(k) plan, you’ll be presented with investment options when you complete the paperwork. Once you deposit money, it will be invested according to your selections.
401(k) plans were specifically created to incentivize workers to save for retirement. If you contribute to a traditional 401(k), your taxable income is reduced due to the 401(k) withholdings. If you’re contributing 6% of your income to a 401(k), you won’t owe taxes on that percentage of your income. With a Roth 401(k), instead of saving on taxes in the year you contribute money to your 401(k), you’ll enjoy the savings when you withdraw it in retirement.
How Does a 401(k) Work?
You may be asking yourself, how does a 401(k) plan make money? The main way you will see your 401(k) grow is from your contributions (and your employer’s, if they offer a match). Once you stop contributing, what happens next?
So, remember the investment options you were given when you signed up for the plan? Your choices told your 401(k) provider how to allocate the money in your 401(k). A common investment option is a target-date mutual fund. This type of fund will contain a mixture of investments, including stocks and bonds, managed to maximize returns while minimizing your risk as you near retirement age. Generally, you’ll be advised to invest in riskier funds when you’re younger and move towards more stable investments as you age.
The money you see in your 401(k) and what you’ll be able to withdraw in retirement are made up of contributions, plus earnings from your investments, plus interest.
How Does It Grow When You Stop Contributing to It?
When you stop contributing to your 401(k) plan, don’t expect to see your balance grow at the same rate. But how much your balance will grow will depend on a few factors.
Interest is one of the big factors in the continuing growth of your 401(k) plan’s balance. When you select a fund to invest in, that fund may include CDs, bonds and/or money market funds—all investments that generate interest. And the larger your balance, the larger those interest payments will be. Simply put, 5% of $10,000 is more than 5% of 100,000.
Other investments might generate earnings based on the market, such as stocks and ETFs. You may see greater volatility in these investments, with earnings either being very good or very bad. When you choose what to invest in, you set your risk profile—riskier investments have the promise of a higher payout but also can suffer markedly when the market turns.
One of the most important things to consider when thinking about how much your 401(k) balance will grow once you stop contributing is compounded growth. When you earn money, either from interest or earnings, that amount is put back into your 401(k) and invested. For a very simple example, let’s say you have $1,000 that you invest for one year and it earns $100. Your 401(k) will add that $100 to the pot and invest $1,100 the next year for a return of $110.
On a small scale like that, it might not seem impressive. But compounding interest and earnings is the most meaningful way that a 401(k) plan will continue to generate growth after you stop contributing. If you add a couple zeroes to the end of those example figures, you’ll soon see the point.
The Bottom Line
While your 401(k) account will likely continue to grow after you stop contributing to it, that growth will be limited by the market, your plan’s balance and other factors. The growth can vary over time as any one of those things changes. In order to get a good idea of what yours could look like you may need to work directly with a professional financial advisor to help you calculate the estimation for your account.
Retirement Tips
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Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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Use SmartAsset’s free retirement calculator to see if you’re on track to meet your retirement goals.
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You may find your company’s 401(k) plan may not be the best option for you. And you may get better investment choices and tax breaks if you open an IRA or a Roth IRA. To help you decide, we published articles on the best IRAs and the best Roth IRAs.
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Source: finance.yahoo.com