Want to be a 401(k) millionaire? 4 tips all future retirees should know

Given that the average 401(k) balance for the 65-and-over crowd is $270,000 (according to Vanguard), it’s safe to conclude that there aren’t many 401(k) accounts worth $1 million or more. Indeed, the average is weighted by a bunch of people with much smaller retirement accounts.

There are certainly some seven-figure 401(k) accounts out there — and some of them are owned by people who were regular wage earners. Retirement plan administrator and fund company Fidelity reports that about 2 percent of the 23 million participants in its workplace retirement plans have balances of more than $1 million.

So what did the few do that the many didn’t? Here are four things the typical 401(k) millionaire knew — or knew how to do — when building their nest egg.

1. Maximize Your “Free Money”

Most employers that offer 401(k) plans will also contribute additional funds to match a portion of their employees’ contributions. Of course, it’s usually not a massive amount. The employer contribution is typically limited to 6 percent of the employee’s salary, and Fidelity reports that the average employer contribution last year was just 4.8 percent of a worker’s salary.

Still, that can be several thousand dollars a year for most workers.

Image source: Getty Images.

The catch: Most employers only match their contributions to the extent that you make yours. If your company offers a 100% match on the first 6% of your wages you contribute, and you only direct 3% of your pay into your 401(k), your company will also contribute just 3%. If you don’t put your own money into a 401(k) account, your company won’t either.

So, quite simply, you should always aim to contribute at least enough to get the maximum matching funds that your employer offers. That’s free money you shouldn’t leave on the table.

Obviously, you don’t have to only contribute the minimum necessary to ensure your company’s maximum contribution to your retirement savings account. Even non-matching contributions give you the opportunity to invest for the long term and reduce your taxable income while you work. So you should contribute more if possible, assuming you like the plan options.

2. Your plan’s best-performing fund option might be the simplest

Your 401(k) plan will most likely be administered by a mutual fund company, and in most cases will limit your investment options to your own funds. That’s good. These are probably cost effective for the admin and therefore cost effective for you.

However, just because a fund is available to you in a 401(k) plan doesn’t necessarily mean it’s a great choice for you. In fact, you may be best served by sticking with the offerings fund company’s less interesting — index funds that track the performance of familiar benchmarks such as S&P 500 or the Nasdaq Composite.

Believe it or not, most actively managed mutual funds that aim to beat the market end up underperforming it. Data collected regularly by Standard & Poor’s shows that over the past five calendar years, nearly 79% of large-cap mutual funds available to U.S. investors have tracked the performance of the S&P 500. Over the past 10 years, 87% of those mutual funds have followed the index.

One of your plan administrator’s funds may be the exception to this statistic. That’s unlikely to be the case, though. The strategy with the best chance of success and the lowest risk is to invest in mutual funds that are designed to match the performance of the broad market.

3. Don’t settle for any of the default options

Although it’s not common, some employers—and even some states—require employees to be automatically enrolled in a 401(k) retirement plan if the company offers one. The employee doesn’t even have to fill out any paperwork — unless they make an active choice to either opt out or choose their own investment options, the employer simply automatically enrolls them using the default contribution and investment options.

But your future financial health is at stake, so it is better for you to take an active role and choose your investment options. Complete the required paperwork and choose to deposit a significant percentage of your salary into your retirement account. Again, make sure it’s enough to qualify for every dollar of matching funds your employer is willing to contribute on your behalf. That should be your minimum starting point.

Perhaps the real stumbling block with the default options for most 401(k) plans, however, are the funds you’ll end up owning. These will likely be target date funds, which feature portfolios that become more conservative as you approach retirement age. While this is a well-intentioned approach to the problem of managing asset allocation risk, it’s a one-size-fits-all solution that may not actually be the best for you. You’ll usually be better off picking your allocations by hand. It will probably require some paper as well.

4. It really is a matter of time

Last but not least, as wise as most 401(k) millionaires might have been in navigating their choices, most of them would admit that it wasn’t their actions of genius that mattered most. Time and the power of compound growth did most of the work. Investors only provided seed money.

The chart below illustrates this idea by plotting the growth of a portfolio built on annual investments of $7,000 in an S&P 500 index fund, yielding an annual return of 10% per year. Over 30 years, this hypothetical person would contribute $210,000 to the account. But because the increase in value each year can produce growth of its own in subsequent years, your overall gains snowball. The end result? A nest egg worth just over $1 million at the end of the three-decade period, most of it reflecting returns on invested money.

Data source: Calculator.net. Chart by author. For hypothetical and illustrative purposes only. You can get different results.

This hypothetical example is not a completely accurate description of what you can expect from your 401(k). What is not reflected here is market volatility. Although the S&P 500’s average returns have been about 10% per year, results from each year vary widely. In some years, the market gains 20% or more in value. In other years, it loses ground.

However, the important aspect is still the same, and the chart makes it obvious. There’s a point where most 401(k) millionaires start to see their retirement accounts get really big. More than half of their net earnings occur in the last third of their investment period, when growth from their previous earnings becomes a significantly larger factor than their new money contributions. The key is simply to stick with the plan for the first two-thirds of your career, to keep making steady contributions even when progress is slow.