Monday, November 01, 1999
How to retire a millionaire
BY AMY HIGGINS
The Cincinnati Enquirer
I'm going to retire a millionaire. No, really. It's true. This is not a goal, or even a pipe dream. This is a mathematical fact.
Achieving this seemingly fantastic goal is a simple function of contributing to my company's 401(k) plan. And then leaving it alone.
Here's how it works: Assume my constant contribution of 6 percent of my current salary. Assume Gannett Co. Inc., The Enquirer's parent company, continues to match 50 cents of every dollar I contribute. Now assume that the stock market continues its average historical returns of 10 percent a year.
Just on the those constants alone not accounting for any raises I might receive between now and then I will retire at age 65 with almost $1.6 million in the bank.
You can, too. The math doesn't work for me any differently. And, believe me, it isn't my salary that is going to make me a millionaire.
The secret here is compound interest. And the trick is letting it happen. Compound interest means that interest earned last year will earn money itself this year. To wit: $100 turns into $110 at 10 percent interest. Instead of turning into $120 (another 10 percent on the original $100), your total becomes $121 (10 percent on the $110).
That $1 seems insignificant now. Seven years of 10 percent compound interest will turn that $100 into almost $200. Seven years of simple 10 percent interest leaves $170. Imagine the difference over 40 years, adding $2,000 or $3,000 to the pot each year.
But the trick is letting that happen. According to Hewitt Associates LLC, a human resources consulting firm in suburban Chicago, 57 percent of people changing jobs cash out of their 401(k)s.
The good news is that plan participants are beginning to show resistance to taking the money, paying taxes on the withdrawal and spending it, said Mike McCarthy, Hewitt's defined contribution consultant. However, it is still quite alarming to see that many participants view the cash payment as a sudden windfall that's a big mistake.
Hewitt's survey found that many people didn't cash out because of the taxes and penalties. Indeed, most early withdrawals from retirement plans incur penalties and taxes that could cut your savings in half.
Some windfall. More important, however, is the potential that these people are losing.
It's important to realize that even small balances in a qualified plan or IRA could grow substantially over time, Mr. McCarthy said.
Hewitt's analysis indicated that the smaller the balance, the more likely the employee is to take the cash payment. Seventy-eight percent of payouts were for balances under $5,000, the study found.
You sure could do a lot with an extra few thousand dollars, especially going into the holidays. But what could you do with an extra $140,000? That's how much the $5,000 grows into after 35 years of 10 percent compounded interest. The magic of compounding turns it into $226,000 after 40 years even if you don't add another dime to it.
But let's say you do add to it. Let's say you roll your 401(k) into an IRA, and for 40 years, add $2,000 a year. (You could add more; but only $2,000 for most people is tax-deductible right now.) Keeping our rate of return an assumed 10 percent, you'll have $1.1 million after 40 years.
When you consider that an employee changes jobs an average of five times during his career, those five balances could add up to a significant amount over time, Mr. McCarthy said.
I never said I was going to be the only millionaire.
Amy Higgins writes about personal finance for the Enquirer. You can reach her at 768-8373; email@example.com; or Your Money, The Cincinnati Enquirer, 312 Elm St., Cincinnati 45202.
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