If your company offers a 401(K) plan, it can be an effective way to save for your future. With a 401K you get tax benefits, contributions are automatically deducted from your paycheck and, often, companies offer a match, which is essentially a guaranteed return on investment. If you need to brush up on all things 401K, consider consulting my (extremely extensive) guide: Retirement Savings 101- Taking Advantage of Your 401K.
In their most recent Retirement Analysis (Q4 2019), Fidelity documented that the average 401K balance had reached a record high of $112,300. As you might imagine, there was considerable disparity between different age cohorts.
The short-lived record notwithstanding (coronavirus…again), these figures seems astonishingly low compared to what you should have saved up to afford a comfortable retirement. If the real median US household income is $61,937 per year, then a $200K balance at age 65 isn’t even enough to fund four years of retirement spending. Even if you assume strong market performance and income from Social Security it is highly unlikely that you will be able to sustain your lifestyle.
What if you’re 32? Retirement is a long way off. It’s difficult to tell if you are on track or not. If only targets existed so you knew how much you should have saved, at what age, and what range of outcomes are reasonable.
Well you came to the right place! In this post, I introduce the Retirement Matrix which is a simple system that you can use to benchmark your retirement savings against established targets. These targets span a range of investment outcomes that bound the evolution of your wealth to let you know what is achievable. I think you’ll be surprised by the results.
The Retirement Matrix
If you are like most Americans, then I will assume that your Defined Contribution Plan (i.e. 401K or variant thereof) represents your primary retirement savings vehicle. As such, the Retirement Matrix consists of 3 parts:
- Age
- Contribution rate
- Return on investment
From these 3 variables we can define a rich set of scenarios to capture the evolution of your wealth.
The Matrix is broken out into 9 “scenarios” that define the range of possible outcomes. The level of Contributions to your 401K is the variable you can directly control. The Market Return you indirectly control via asset allocation but is ultimately dependent on prevailing economic conditions and corporate profitability.
Each box of the Matrix has an associated set of assumptions that describe that scenario. First, let’s define the general Return and Contribution assumptions which will allow us to see how the boxes fit together:
Return Assumptions
| Low Return | Mid Return | High Return |
| 4% | 6% | 8% |
The Return Assumptions span a range of possibilities that are generally representative of different assets allocations and risk tolerances (i.e. Conservative, Moderate, Aggressive). If you are 100% invested in Stock, then you can probably expect an 8% long run, average rate of return. Similarly, if you have a Moderate 60:40 portfolio then you can expect an average return in the range of 6%. Finally, if you are more Conservative and run a 40:60 portfolio, then expect a long run return of ~4%. This is not to say, these returns are guaranteed; it’s conceivable that stocks perform poorly, and you receive less than 8%. However, these return assumptions do represent long run tendencies that have held up over time and through many market environments.
Contribution Assumptions
| Low Contribution | Mid Contribution | High Contribution |
| $5,000 | $10,000 | $19,500 |
As a baseline for the Contribution Assumptions I assumed annual earnings of $50,000. I did this for a few reasons:
- This level of income is broadly achievable for most Americans.
- If you are earning $50,000 per year, then annual savings of $5,000 represents 10% of your pre-tax income; this level of saving should be more than achievable for you. Furthermore, if you are maxing out your 401K and socking away $19,500 per year, then your contribution rate is ~40%; a difficult level of saving to attain, but still feasible.
- $19,500 is the max individual 401K contribution in 2020 for those < 50 years old. Under certain circumstances you may be able to save more (again, see my Guide), but this serves as a good rule.
Furthermore, in addition to individual contributions I assumed an annual $2,000 Employer Matching Contribution. This was based on a salary of $50,000 and a, fairly common, 4% matching structure (100% for first 3%, 50% for next 2%).
Now you can see how the Matrix fits together:
- Box 1: Low Return = 4%, Low Contribution = $5,000
- Box 2: Low Return = 4%, Mid Contribution = $10,000
- Box 3: Low Return = 4%, High Contribution = $19,500
- Box 4: Mid Return = 6%, Low Contribution = $5,000
- Box 5: Mid Return = 6%, Mid Contribution = $10,000
- Box 6: Mid Return = 6%, High Contribution = $19,500
- Box 7: High Return = 8%, Low Contribution = $5,000
- Box 8: High Return = 8%, Mid Contribution = $10,000
- Box 9: High Return = 8%, High Contribution = $19,500
Target 401K Balance by Age
We have described how the Retirement Matrix works and the Return and Contribution Assumptions involved. Now, we can set targets to see how much you have saved in your 401K by Age and Years Worked.
The assumed starting working age is 22. If you graduated later or are an older worker, then use the Years Worked column to scale your results.
Target 401K Balance by Age and Years Worked
You can see, that after 38 years of working you will have between $658,179 and $5,290,159 saved in your 401K. These results depend on your chosen level of contributions, assets allocation and a realistic cycle of Bull and Bear markets.
In my experience, the results in the Mid-Range (i.e. Mid Return & Mid Contribution) are the most realistic. It’s plausible that you started saving at 22, max your 401K and catch impressive market returns of +8% per year. Furthermore, the 401K contribution limit should go up over time which will allow you to save more. However, the rollovers that I’ve seen from my clients (who generally have above average incomes and are diligent savers) tend to fall in the $1,000,000 – $3,000,000 range. I’ve seen plenty that fit within the lower range of the chart ($500,000-$1,000,000), but that is usually because they started saving later.
If you’re reading this post, it’s likely that your results will tend toward the Mid to Lower end of the range. The median age of an American is 36, so use the Middle to Lower tiers as your baseline for planning but know the high end numbers are possible if you want to take a shot at it.
Invest…Because Inflation Matters
I’ve talked a lot about inflation on this blog and that’s because it is REAL and IMPORTANT!
If you retire at 60 with between $1,000,000 – $3,000,000 and live 25 years in retirement, then you should be able to draw between $40,000 and $150,000 annually from your investments. However, these figures are quoted in today’s dollars and that $40,000-$150,000 is not going to go as far in year 25 as it does today. In fact, if inflation averages 2% over your retirement, then your real income in year 25 will only be $24,381 and $91,429, respectively. If you live 35 years in retirement, then your purchasing power will be further eroded to $20,000 and $75,000, respectively.
The below graph (courtesy of the American Enterprise Institute) charts inflation for different sectors of the economy. You can see that the services sector has been the most broadly impacted by inflation. Of particular concern is the rate of inflation for Medical and Hospital services. As you age, it is quite likely that you will need more medical care and the cost of healthcare have been among the fastest rising!
In particular, Medicare costs are expected to grow at an annual rate of 7.6% from 2020-2028 largely reflecting the continued shift of the baby-boom generation into Medicare. This rate of spending growth is unsustainable in the long run and it’s conceivable that a greater burden will be shifted to retirees. You might not be closing in on retirement age yet, but you can expect your contribution to the cost of care to be higher by the time you do retire, and you need to be prepared for it.
Conclusion
Your 401K is one of the most potent savings vehicles at your disposal to build wealth. It comes with numerous tax and employer benefits which makes it dominant over other retirement accounts like IRAs and Roths. If you want to secure your lifestyle in retirement, and if history is any guide, you need to be taking advantage of what your 401K offers and watching it like a hawk to ensure you remain on track.
To that end, the Retirement Matrix establishes a simple framework with milestones that you can use to evaluate if you have saved enough at any age and if the projected savings at retirement match your expectations. If you find that you need to make adjustments, then consider the different channels that you can use to reach your desired outcome such as increasing your savings or changing your asset allocation.
Saving for retirement is hard enough, but knowing what you need to do can be made easier. Hopefully you find the Retirement Matrix to be a useful guide for you as you build wealth and plan for retirement.
Until next time, thanks for reading!
-Aric Light
