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Perfect World vs. Real World 401(k)

Let’s imagine that you’re 25 years of age, and you’re planning to fund your 401(k)… The American Dream.

We’ll assume that you’ll start out funding that 401(k) at $5,000 a year. As you make a little more, you’ll increase, we’re going to inflate that by 4%. In other words, as you make more and more money, we’re assuming you’re going to up the ante and increase your contribution each year by 4%. So year one, you’ll plan to contribute $5,000.

We’re also going to assume you make 4% in your 401(k) that first year. So the following year, you start off with $5,200. You put in that year’s contribution, increasing by 4% to $10,816. So you just keep adding more and more money. The money keeps growing at 4% (your Internal Rate of Return) Now let’s fast forward to age 64, assuming you’ll retire at the magic age of 65… A number that the government essentially just ‘made up’ when they began Social Security.

Perfect World 401(k) Balance at Age 64 – $960,000.

(Assuming $5,000 initial contribution, 4% increase in contribution, 4% Internal Rate of Return on the 401(k).)

You don’t have to know much about finance to say, “Wow! That’s a lot of money!”

It certainly is a lot of money… on paper. And most importantly, in a Perfect World – absent of fees.

Now let’s take a look at what this account would look like in the real world. A world of fees. A world of financial headwinds. A world where Wall Street has to make money on your money. Let’s keep all other assumptions, but this time we’ll add a 1% annual fee to the 401(k). Just try to think of these fees buried in your 401(k) as headwinds.

So with our Real World 401(k) example, let’s fast forward to 64. Remember what our number was before in a Perfect World with no fees — $900,000 you would have in your retirement account.

Real World 401(k) Balance at Age 64 – $786,000.

(Assuming $5,000 initial contribution, 4% increase in contribution, 4% Internal Rate of Return on the 401(k) – With a 1% Annual Fee)

Now that’s one heck of a headwind if you ask me. Not only was the 1% fee responsible for removing $174,000 from your account and into Wall Street’s pockets, but you also lost the opportunity to use that money over time. Something we in the financial world call opportunity cost.

Not to make your day any worse, but beyond the fees and opportunity cost, we haven’t begun dealing with the largest headwind – The Tax Tumor®

While you’re celebrating stashing away $786,000, even after the fees and lost opportunity cost inside your 401(k)… The government is anxiously waiting to take a 20% or even 30% bite out of your account in your retirement depending on your tax bracket.

To make a bad day worse, what if I told you that with our current assumptions of contributing $5,000/year (increasing by 4% each year, IRR of 4%) – You would, over time (age 25-age 65) contribute around $475,000. Not far from what you’re going to end up walking away with in retirement after Financial Headwinds have had their way with your 401(k).

Do you feel more confused or concerned about how Wall Street is making money on your money? Does the idea of Financial Headwinds on your retirement savings leave you looking for tax-favorable, low-fee options outside of your company’s 401(k)? Give us a call or fill out our Let’s Get Started form today to begin taking control of the Financial Headwinds that could be buried within your retirement savings plan.