Money Advice

Here’s why your 401(k) balance is lying to you

Posted by The Simply Money Advisors Team on Aug 22, 2018 5:05:00 PM

Just recently, the brokerage firm Fidelity shared some noteworthy news: there are now a record-breaking number of “401(k) millionaires” among the 401(k) plans it administers. This exclusive group is about 168,000 strong, up from 118,000 last year. 

And while there’s no doubt these 401(k) millionaires should be proud of their accomplishment (after all, the average 401(k) balance sits around $104,000), we’re here to burst their bubble: they’re not really millionaires.

Wait, what?

Even though their 401(k) balance might read “$1,000,000” when they log-in to their account, that number is misleading. In fact, it’s a downright lie. And it’s all because of that dreaded five-letter word: taxes.

Remember, when you save in a traditional 401(k), you’re making a deal with the government: the government is saying, “We’ll give you an up-front tax break on your contributions as long as you agree to pay your taxes on this money at a later date, once the account has grown.”

Translation? Once retirement hits and you start making withdrawals from your 401(k), Uncle Sam gets a chunk of your balance.

For example, let’s say one of those 401(k) millionaires is in the 12% tax bracket in retirement. Instead of the $1 million, he or she really has about $880,000. Someone in the 22% bracket would have about $780,000.

Obviously, both of those scenarios still leave a nice amount of money for retirement. But neither is as much as originally thought.

This is one of the reasons why a Roth 401(k) is such a powerful retirement planning tool – you contribute money you’ve already paid taxes on, so the account grows tax-free. Then, assuming you’ve held the account for five years and you’re at least age 59 ½, withdrawals on earnings are tax-free. If you see a balance of “$1,000,000” in your Roth 401(k) account, you truly have $1,000,000.

The Simply Money Point

Traditional 401(k) balances don’t account for taxes. So, as you’re planning for retirement, don’t take the number you see at face value. It’s not a true indication as to how much is actually yours.

Are you confident you’ll be able to retire well? If not, educate yourself on how best to manage your life and money. Visit our Retirement Resources library for free online video tutorials, downloadable guides, and live events.

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Topics: Retirement Planning, Investing

Disclaimer

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Simply Money Advisors), or any non-investment related content, made reference to directly or indirectly will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, this content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained here serves as the receipt of, or as a substitute for, personalized investment advice from Simply Money Advisors. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Simply Money Advisors is neither a law firm, a certified public accounting firm, nor a tax advisory firm and no portion of the blog content should be construed as legal, accounting, or tax advice. Please consult your own attorney, accountant, and tax advisor for legal, accounting, and tax advice. A copy of the Simply Money Advisors’ current written disclosure statement discussing our advisory services and fees is available for review upon request. Advisory services offered through Simply Money Advisors, a SEC registered investment adviser. Insurance services are offered through Simply Money Insurance Agency, a separate entity from Simply Money Advisors. Simply Money™ and the spiral symbol are trademarks of Simply Money IP Holdings, LLC.

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