Knowing how much you will have tucked away in your 401(k) is essential for planning your retirement year and knowing what lifestyle you will be able to afford when that year rolls around. Because your future contributions, rate of return and inflation can all vary, use two or three different scenarios to get a clear picture of what will be waiting for you. If you seem to be falling short of your goals, look at what putting off retirement for five years might do, then compare this to investing just 10 percent more than what you are currently setting aside.
Using the Right Calculator
The formula required for calculating even basic compound interest is complex, so for accurate results it's important to use a retirement calculator. These calculators let you input your current 401(k) balance, expected future contributions, a rate of return and the number of years until retirement in order to estimate your retirement income. Some also allow for inflation while showing you the type of monthly income your retirement savings should generate. If the calculator you choose doesn't include a separate option for employer contributions, you can add it to your own annual contributions.
Years of Savings
The earlier you start investing, the sooner a comfortable retirement will be within your grasp. Tax-free compounded interest multiplies substantially over a long period of time. For example, if you began investing $10,000 each year between your contributions and your employer's contributions, and get an average annual return of 5 percent, at the end of 20 years you would have $342,940.91. If you began 10 years earlier, you would more than double this amount to $694,888.11. If you began investing in your 401(k) at age 25 using the same numbers, by the age of 65, you would have more than $1.2 million accumulated.
Estimating future rates of return can be challenging since interest rates and stock prices fluctuate widely. In the early years you may be able to be more aggressive in your choices of stocks or mutual funds for the chance at a higher return. As you get closer to retirement, however, you may want to invest in funds with a lower rate of return but with less risk. A conservative estimate for a rate of return would be 5 percent. An aggressive rate of return could be between 10 percent and 12 percent. If the same person who invested for 40 years at $10,000 each year averaged a return of 10 percent instead of 5 percent, the result would be a nest egg of $5.3 million instead of $1.2 million.
Adjusting for Inflation
Twenty or 30 years from now, $1 million is unlikely to be worth what it is today. According to the Bureau of Labor Statistics, $633,561 in 1994 had the same buying power as $1 million in 2014. If you use a retirement calculator that gives you the option to input inflation, consider using 3 percent, which has been on the high end for the period between 1994 and 2014. Historically, inflation has had sustained periods of 5 percent to 7 percent. However interest rates, during those periods were substantially higher as well.
A published author and professional speaker, David Weedmark has advised businesses and governments on technology, media and marketing for more than 20 years. He has taught computer science at Algonquin College, has started three successful businesses, and has written hundreds of articles for newspapers and magazines throughout Canada and the United States.