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 is performing. Here’s how to estimate the future performance of your 401(k). If you want personalized advice on your retirement planning, 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) is taken out of your paycheck before taxes and is only taxed when you withdraw from it in retirement. A Roth 401(k) is similar, but inverse, in that the money going into it has already been taxed, so it won’t be taxed when you withdraw from it in retirement. You can withdraw from either type of 401(k) without penalty at age 59.5.
When you sign up for a 401(k) plan, you’ll be presented with investment options as you complete the paperwork. Once you deposit money, it will be invested according to your selections.
401(k) plans are created specifically to encourage employees to save for retirement. If you contribute to a traditional 401(k), your taxable income is reduced because of 401(k) deductions. If you contribute 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 the year you contribute money to your 401(k), you’ll enjoy the savings when you withdraw them in retirement.
How does a 401(k) work?
You may be wondering: How does a 401(k) plan make money? The main way you’ll see your 401(k) grow is through your contributions (and those of your employer, if they offer a match). What happens next if you stop contributing?
Do you remember what investment options you got 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 mix of investments, including shares and bonds, which manage to maximize returns while minimizing your risk as you approach retirement age. In general, you are advised to invest in riskier funds when you are younger and move to more stable investments as you get older.
The money you see in your 401(k) that you can withdraw in retirement consists of contributions, plus income from your investments, plus interest.
A financial advisor can help you make calculations for different retirement scenarios. Make a match with a financial advisor today.
How does it grow if you no longer contribute to it?
When you stop contributing to your 401(k) plan, don’t expect your balance to grow at the same rate. But how much your balance will grow depends on a number of factors.
Interest is one of the big factors in the continued growth of your 401(k) plan balance. When you select a fund to invest in, that fund may include CDs, bonds, and/or money market funds, all of which are investments that earn interest. And the larger your balance, the larger the interest payments will be. Simply put, 5% of $10,000 is more than 5% of 100,000.
Other investments can generate income based on the market, such as stocks and ETFs. You may see greater volatility in these investments, with returns being very good or very bad. When you choose what you want to invest in, you determine your risk profile. Riskier investments promise a higher payout, but can also suffer significantly if the market turns.
One of the most important things to consider when considering how much your 401(k) balance will grow once you stop contributing is compound growth. When you earn money, either from interest or income, 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 in for a year and you return $100. Your 401(k) adds that $100 to the pot and invests $1,100 the next year for a return of $110.
On such a small scale it may not seem impressive. But compounding interest and income is the most meaningful way a 401(k) plan will continue to generate growth after you stop contributing. If you add a few zeros to the end of those sample numbers, you’ll quickly see what the fuss is about.
It comes down to
While your 401(k) account will likely continue to grow after you stop contributing to it, that growth is limited by the market, your plan balance and other factors. Growth may vary over time if any of these things change. To get a good idea of ​​what your situation might look like, you may need to work directly with a professional financial advisor to help you calculate the estimate for your account.
Retirement tips
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Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can interview your advisors for free 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 reach your retirement goals.
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Your company’s 401(k) plan may not be the best option for you. And you may get better investment choices and tax benefits if you open an IRA or a Roth IRA. To help you decide, we’ve published articles on the best IRAs and the best Roth IRAs.
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Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
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