This 401k calculator estimates your balance at the retirement age, the total interest earned and the monthly or annual annuity payment income you will get then. There is in depth information on how to prepare for the inactivity period below the form.
How does this 401k calculator work?
This retirement calculator allows you figure out the growth of your 401k account by estimating its ending balance before the desired age to retire as well as the gross monthly or annually income you will most probably receive during the benefits phase. It also returns the number of years left to contribute, the figure of the total principal saved and interest earned and the number of years you will benefit from your savings by considering the assumed life expectancy.
Before explaining the formulas behind it we should first make a short list of the variables an individual needs to know in order to perform this type of calculation:
- Current and retirement ages as well the life expectancy value.
- Existing 401k savings is the case.
- An assumed average monthly 401k contribution you can make on a regular basis within the accumulation phase, together with a figure of how much your employer/s will contribute on a monthly basis to your 401k account if the case.
- A fixed average annual investment’s return rate or the so called interest percentage.
The algorithm behind this 401k calculator is based on the formulas explained below:
- No. of years left to contribute until retirement = [A]
[A]= Assumed retirement age – Your age today
- Account balance at the end of career = [B]
[B] = CNB*(1+ROI/1200)^( ([A] * 12))+(YMC+EMC)/(ROI/1200)*((1+ROI/1200)^(([A]*12) )-1)
CBN = Your 401k current balance
ROI = Estimated annual return on investment
YMC = Your monthly 401k contributions
EMC = Your employer’s monthly 401k adding
- Total principal saved in [A] years = [C]
[C] = CBN + ([A]*12*(YMC+EMC))
- Total interest earned in [A] years = [D]
[D] = [B] - [C]
- No. of years of retirement = [E]
[E] = Estimated life expectancy - Assumed retirement age
- Gross monthly pay out during retirement = [F]
[F] = [B]/((1-〖(1+(ROI/1200))〗^(-[E]))/(ROI/1200))
- Gross annual pay out during retirement = [G]
[G] = [F]*12
Example of a calculation
Let's assume an individual with the following status:
- current age of 30 wants to retire at 65 years and expects to live until 85;
- has a 401k current balance of $100,000 and can contribute monthly a value of $1,000 ($500 by employee and the second half by employer)
- the fixed return rate expected is 5.5%. How will the situation look?
■ No. of years left to contribute until retirement = 35.00
■ Account balance at retirement = $1,953,430.01
■ Total principal saved in 35.00 years = $520,000.00
■ Total interest earned in 35.00 years = $1,433,430.01
■ No. of years of retirement = 20.00
■ Gross monthly pay out during retirement = $13,437.40
■ Gross annual pay out during retirement = $161,248.77
401k plan history and definition
The start of the 401k plan was in 1978 when the Congress voted for this part in the Internal Revenue Code tax law that aimed to regulate significant benefits in taxes for the ones preparing for retirement by making periodical savings.
By this regulation people were encouraged to save and deposit money for their pension time, thus the 401k plan is practically an account anyone can set up and in which both the owner and his employer define a desired regular contribution level. In this account you can add regularly up to a certain part of your monthly salary (usually expressed as a percentage), while according to the law your employer must approve that value.
These efforts are critical in planning your retirement, thus the more you manage to contribute the better will the future be. However, it should also be mentioned that IRS institution establishes a limit of your own overall annual 401k contribution for each year which take account of the living costs index. For instance in 2014 the value of the imposed limit was $17,500.
On the other hand, as per 2014 your employer may contribute as much as desired, as there is no imposed limit in its case, except that its annual contribution cannot be greater than the lesser between 100% of the employee's participation and a capping value of $51,000.
The advantage of the 401k plan is that the contributions made by the employee and employer are not included in the tax calculations, which result in some savings from taxes you can make, as the overall you will pay is lower than by no contributing to such an account.
Apart from this main advantage a 401K account came with up some other ones if we compare it with a traditional or Roth IRA, where savings may or may not be tax deductible as they depend on more complex factors.
Needless to say that the account is administrated by a specialized and independent institution, while you have the right to choose the investment’s profile (low or high risk profile) as well as the right to choose what instruments to invest in with the counseling of that institution.
What investment strategy to choose?
While there is no certain rule to follow, financial advisors recommend to first study and then decide on what to invest, while being permanently aware that you need to adapt your strategy as the years go on and as your risk profile changes. Needless to say that the instrument’s return rate is volatile over time and may change significantly from one year to another. For instance younger people have the tendency to take risks more often that older people as they are extremely motivated by significant performances and return in comparison with people getting closer to the retirement phase. Generally speaking when analyzing an investment option you have to consider few things, such as:
- The impact and the risk probability.
- The term of the investment.
- The perspectives and the liquidity of the investment.
Regarding the 401k investment strategy, some financial experts recommend a strategy that depends on your age and on the risk appetite as explained below:
- the number of years old should define the percentage of safe investments instruments such as fixed income funds cash and bond funds; while the rest up to 100% of your funds should be invested in instruments considered riskier such as stocks or similar transactions.
- The risk appetite can modify the allocation explained above with a maximum of 3 up to 5% down or up. For instance an individual at the age of 48 years old may decide to invest as follows: 51% in safe instruments (48% + 3% as he prefers low risk profile) and the rest of 49% in stocks.23 Jan, 2015