There’s an urban legend that Albert Einstein proclaimed compound interest to be the most powerful force in the universe. Whether he said this or not, how your money can grow over the long-term can be something to behold.
A Nest Egg of $1 Million Dollars in 20 or Less Years – A Hypothetical Example
Consider a business owner, or any employee, who is able to put in the 2020 maximum contribution of $19,500 into his or her 401(k) account tax deferred. If we assume each year this amount is contributed and these contributions earn an annual 8% return on investment, in a bit over 20 years, you would have built up of over $1,000,000 in retirement savings. This assumes there is not an employer match. Meanwhile, you’d have only contributed $398,125. That’s the power of compounding. Oh, and thanks to compounding, you’d reach more than $2,000,000 in your account in 27.8 years and have invested $520,000. Time can be on your side.
Now let’s assume you receive a 4% match on top of what you contributed as described above. Let’s say you are a business owner and you earn $200,000 per year. For simplicity, your salary never changes and you receive the same matching contribution each year. With this match, it only takes you 17 years and 1 month to attain one million dollars in savings and 24 years and one month to surpass two million.
There are no guarantees on future performance for sure, and we know future performance will vary from the past and markets will experience good and bad years. For reference, historically a portfolio of 60% in U.S. stock funds and 40% in U.S. government bonds achieved an average 8.27% annual return.+
401(k) Savings Can Add Up, Tax Benefits Are Meaningful, and 401(k) Plans Are Pretty Inexpensive for Your Business
Yes, you can see how regularly contributing can really add up over 20 or more years in a 401(k). You probably also know it can save you money on this year’s taxes too.
However, you may not be aware that offering 401(k) benefits can be a low-cost program for any size business. Providers like ShareBuilder 401k start at less than $100 per month in administration for a business of 10 or less employees. And if your business has 1 to 100 employees and this is your first 401(k) plan, your business can qualify to receive half of these costs back in government tax credits for the first three years of your plan (up to $15,000 in tax credits). Lastly, while an employer match is optional in a 401(k), if you do offer a match, it’s typically 100% tax-deductible.
Pretty cool reasons – potentially millions of them – to start a 401(k) plan today.
+ Based on SBBI data from 1926-2018. Assumes an account holding 50% in large stocks (S&P 500), 10% in small business stock fund, 35% in long-term U.S. government bonds and 5% in U.S. Treasures. This portfolio averaged 8.27% annual return during this time frame. The allocation is 60% in stock funds and 40% in bond funds.