Welcome to the third segment of compounding returns' fifteen part series on how to build a million dollar net worth in only 15 years. If this is your first visit to compounding returns, make sure you sign up free to our RSS Feed or Email Newsletter. That way you will never miss a tip or strategy which may enable you to meet your goal of building a million dollar portfolio in 15 years.
The 15 Year Millionaire Plan is structured as a series of posts, starting with Year 0 (which focuses on what you need to get started on this ambitious wealth building strategy) and progressing through Year 15. Each post focuses on another important building block in your personal financial strategy. So far we have covered Year 0 (What You Need to Get Started), Year 1 (Employment Considerations), and Year 2 (How to Purchase Your First Home- The 15 Year Millionaire Way).
Working the Plan:
In year 3 of the 15 Year Millionaire Series, we will discuss the importance of your 401(k) or other tax deferred retirement savings as the cornerstone of your long term savings, and how the tax deferral, automatic nature of the 401(k) savings plan, and automatic growth of savings work in your favor as you build your way towards a million dollar net worth in 15 years.
Throughout the 15 year millionaire series, we have consistently emphasized the importance of modifying the strategies and tips presented throughout the series to your own particular situation. We've received some questions from readers throughout the series regarding some of the particulars, and how the plan should be modified to their circumstances. We encourage these questions, and the resulting discussion of strategies, as each reader's situation is somewhat different, and we all have something to add to the discussion! So keep adding your questions and comments to the comments section below.
The key to working the 15 Year Millionaire Plan is to modify the strategies to fit your particular situation. Rather than changing your life to fit the plan, its important to change the plan to fit your life. As always, however, we will use a fictional situation for illustrative purposes in describing the benefits of a 401(k) savings plan on your long term financial security.
401(k) Considerations:
During Year 1 of the 15 Year Millionaire Series, we covered some of the basics of 401(k) investing, as well as the minimum amount that you need to contribute in order to build your net worth in the most tax efficient manner.
A Year 1 Refresher:
From the action items in Year 1 of the 15 Year Millionaire Plan, you will recall that we insisted upon contributing 15% of your Year 1 $50,000.00 Salary to a 401(k) savings plan. This resulted in a total contribution of $7,500.00 a year. Adding the 6% employer match, or $3,000.00 the result was a total contribution of $10,500.00 towards your retirement goals during year 1 of the plan.
Tax Advantages of 401(k) Contributions:
Although we covered the tax advantages of 401(k) contributions during Year 1 of the plan, this particular fundamental is important enough to review. Based on a 15% contribution to your 401(k) program, and assuming a salary of $50,000.00 a year (which places would place you in the 25% income tax bracket) your total take home pay if you chose not to participate in a 401(k) program would be $3,125.00 a month.
After making your 15% 401(k) contribution, however, and factoring for the employer match, the result will be a monthly take home pay amount of $2,656.00, a reduction in pay of only $469.00 on contributions of $875.00 a month.
You may ask how you can contribute $875.00 a month to your retirement while only reducing your take home pay by $469.00. This is possible because you lower your realized income through tax deferral while the employer match similarly increases the level of your contributions.
No wonder all of those personal finance websites (like compounding returns) always tell you to grab that employer match.
As you will see in the section below, maintaining a 15% 401(k) contribution over time quickly adds up to a significant sum of money, especially when factoring for salary increases over time.
Your 15% Contribution Over Time:
Tax deferral and the effect of a decreased taxable income are only some of the benefits of a 15% 401(k) contribution sustained over time. Throughout the 15 Year Millionaire Series, we assume that the participant will be successful within their chosen profession and earn a 5% annual salary increase throughout the course of the 15 year plan. By keeping 401(k) contributions locked in at 15%, annual contributions to a 401(k) plan throughout the course of the series will grow according to the list below. (Including the employer match of 6%)
Year 1: $10,500.00
Year 2: $11,025.00
Year 3: $11,576.25
Year 4: $12,155.06
Year 5: $12,762.82
Year 6: $13,400.00
Year 7: $14,071.00
Year 8: $14,774.00
Year 9: $15,513.10
Year 10: $16,288.75
Year 11: $16,500.00 (50 or below), $17,103.20 (50 and above)
Year 12: $16,500.00 (50 or below), $17,958.36 (50 and above)
Year 13: $16,500.00 (50 or below), $18,856.28 (50 and above)
Year 14: $16,500.00 (50 or below), $19,799.09 (50 and above)
Year 15: $16,500.00 (50 or below), $20,789.04 (50 and above)
As you can see, due to the 5% salary increases over time, contributions max out at Year 11 of the 15 Year Millionaire Series if the participant is 50 or younger. For those who are older than 50 years of age, catch up contributions allow for a maximum of $22,000.00 a year in tax deferred contributions, so this 15 year schedule will not quite max out eligible contributions over a 15 year time-frame unless contributions are increased.
The Long Term Effects of a Sustained 15% 401(k) Contribution:
Sometimes, it is easy to lose sight of the long term effects of sustained contributions and compounding returns. Using the typical 15 Year Millionaire participant, the results of this long term sustained contribution coupled with the 6% 401(k) match will result in a 401(k) account balance of approximately $420,000.00 by the 15th year of contributions.
15 Year Millionaire Stats: End of Year 3
As promised, each week we will offer another set of tips and challenges for becoming a millionaire in 15 years, along with tracking the effect of these changes and strategies over time. By following the 15 year millionaire plan, your accounts and net worth will be somewhere in the neighborhood of the following. (Assuming that you began the plan within the parameters described in the first post of our series. All changes instituted throughout the program remain in effect. In addition, we will assume a 5% annual salary increase as well as the following: 10% annual stock market returns, a 1.5% return on savings, and a 3.0% annual increase in the value of real estate.)
Salary: $55,125.00
Bank Account- Emergency Savings ($150.00 per Month): $11,836.00
Bank Account- Down Payment on a Home: $0.00
Debt- Mortgage: $77,034.00
Real Estate Value: $154,500.00
401(k) (15% Contribution + 6% Employer Match): $38,778.00
Roth IRA (Max Contribution): $17,600.00
529 Account: $0.00
Bank Account- Itemized Savings ($100.00 per Month): $3,672.00
Taxable Brokerage Account Balance: $0.00
Net Worth: $149,352.00
Next Monday's Post:
Next Monday's post will focus on your Roth IRA and how important it is to your long term savings goals. Together, we'll explore why the Roth IRA remains one of the best vehicles to invest for the long term.Click here to read Year 4: Invest in Your Roth IRA.
For more information on investing and long term financial considerations visit this week's Carnival of Personal Finance.
Great article! 401k contributions are extremely important and coupled with a Roth IRA you're at a 0 sum game for money coming out. Many people forget how such a small amount consisitently invested can lead to huge returns.
ReplyDelete-Ravi Gupta
I think the salary increase, the starting valuation of the home and 10% annual return are all plumb but not likely. If you want to assume 3% return on the home, it should be at the 100k price. Otherwise, assume flat in the current market conditions for the next several years.
ReplyDeleteI'm using pretty conservative historical data. You can argue for this data no longer being valid in light of recent economic developments and the real estate downturn, but until we are on the other side of the recession looking back, its hard to know what returns will turn out to be.
ReplyDeleteAny forward looking statement is going to take a lot for granted. I've tried to assume fairly conservative returns in every regard.
I'm confused on why the value of the house jumped from $100,000 house, in Year 2 and now is $154,400 one year later.
ReplyDelete