How to Retire Early with Your 401k Retirement Savings Plan

After my parents moved to Florida in the mid-1980s, Mom and Dad would send us the job ads from the Sunday newspaper. In one letter, Mom circled an ad that she thought was perfect. “Look at this one,” she wrote. “It pays $401,000.” On closer inspection, we realized the job offered a 401k retirement savings plan, not a $401,000 salary.

Unfortunately, no one in our family ever came close to making $401,000 per year. If you’re in the same boat, you can still have the best way to retire early. The trick is taking full advantage of a 401(k) or any other retirement savings plan available to you.

A recent survey found that nearly half of people polled believe they won’t be able to afford to retire. The survey, which was commissioned by SunAmerica, Inc., and the Teresa & H. John Heinz III Foundation, found that people age 25 to 55 believe they won’t have enough money saving for retirement. The individuals surveyed feel this way because they are unable to save money now. Perhaps, as a public service, someone should have told the participants in the survey about 401k retirement savings plans.

Of course, I’m amazed they could find anyone willing to participate in a survey. Every call I get that purports to be a survey ends with a sales pitch for aluminum siding. If someone called me to participate in a survey regarding retirement, I would assume a broker or insurance salesperson is on the other end of the line.

Whether you’re shooting for early retirement or retirement at a more typical age, 401k retirement saving plans will be a key element of your strategy. About 25 million Americans are now participating in 401(k) plans. If you’re not among them, you should be.

In 1992, 18.5 million workers participated in 401(k)s and had $410 billion invested. According to the Spectrem Group in San Francisco, Americans have now stashed away over $1 trillion in 401(k) retirement savings plans as of March, 1998. Though much of that increase in assets might be attributed to the booming stock market, more workers are taking advantage of this tax break.

Those trillion dollars doesn’t include the $420 billion invested in 403(b) and 457 plans. Section 457 plans are for employees of state and local government, as well as certain individuals who work for tax-exempt organizations. Section 403(b) plans are tax-sheltered annuity programs for employees of public schools, colleges, and certain not-for-profit organizations. These plans are very similar to 401(k)s.

With all of these plans, employees defer a percentage of their salary and invest the money in tax-sheltered retirement accounts. The money is put aside before taxes are taken out. The funds inside the accounts grow and aren’t taxed until withdrawn.

Along with the pension plan tax advantages, most employers throw in a contribution of their own. Depending on the company, the employer may kick in a specified amount for each dollar the employee puts in the 401(k). A typical match is 50 cents for each dollar the employee contributes. Naturally, the employer will only provide this match up to a specified percentage of the employee’s pay, usually 6 percent.

401(k) retirement savings plans with matching contributions from the employer help companies retain employees. The employer’s contribution may not vest for a specified number of years, which gives employees an incentive to stay. With most plans, you’re not eligible for the 401(k) until you’ve been employed at the company for one year.

With 401(k)s, there is a maximum 401k contribution per year that you can put away. Whether you’re Bill Gates or making minimum wage, the rules pertaining to participants in the company 401(k) are the same for every member of the plan. Your net worth won’t approach his, but your 401(k)s will be playing by the same rules.

To retire early, one of the best approaches is to make the maximum tax-deferred contribution allowable. The maximum is currently $10,000 or a lower ceiling established by the plan. Although your employer may only match a portion of that contribution, you’ll still build an enormous tax-sheltered account. Because you’re funding the account with pre-tax dollars, you’ll pay fewer taxes now. The 401(k) and similar plans are the best ways to fund the post-59 1/2 stage of your retirement. The employer’s contribution makes a big difference as you can see in the chart below.

You’ll only be entitled to the 401k employer’s contribution if you’re vested. Always check with your plan administrator to find out when you’ll be vested. At that point, the employer’s contribution becomes yours forever.