What is a 401k?
A 401k is a retirement savings plan sponsored by an employer that allows workers to save and invest a part of their paycheck before taxes are taken out. Earnings from these investments are tax-deferred until the money is withdrawn during retirement.
The unique benefit of a 401k plan lies in the employer matching contributions feature. Some employers offer to match the money you contribute to your 401k plan up to a certain percentage. In effect, this is like receiving free money, in addition to your savings, toward your retirement.
Apart from the regular 401k plan, there is also what's called the self-directed 401k for self-employed individuals. This version of the plan gives the owner more control over investments made with the funds.
How to Use a 401k Calculator?
A 401k calculator is a tool designed to help you estimate the future value of your 401k account. The factors it considers include:
Age and planned retirement age
Current 401k balance
Personal and employer contribution rates
Employer matching limit
Estimated annual rate of return
Anticipated number of years in retirement
Expected income tax during retirement.
After you have accurately input these factors, the calculator will help provide an estimate of the balance of your 401k upon retirement, and the duration this may potential last through your retirement years.
An Actual Example to Demonstrate the Calculator
Suppose you're 30 years old and plan to retire at 65. Your current balance in the 401k account is $20,000. Your annual salary is $50,000, and you plan to contribute 5% of your salary to the 401k plan every year.
Your employer has a 100% match policy for up to 4% of your salary. The estimated annual rate of return on your 401k investments is 7%. You expect to be in retirement for 25 years and anticipate an average income tax rate of 20% during retirement.
After inputting these values into the 401k calculator:
Age: 30 years
Retirement age: 65 years
Current 401k balance: $20,000
Annual salary: $50,000
Personal contribution rate: 5% annual salary
Employer match: 100%
Employer matching limit: 4% of annual salary
Expected annual rate of return: 7%
Expected number of years in retirement: 25 years
Anticipated average income tax rate during retirement: 20%
The calculator will provide an estimate of your 401k balance at retirement, the potential monthly withdrawals, and how long these savings might last.