A 401(k) is one of the popular retirement accounts that American workers use to save for retirement. Usually, employees contribute a percentage of their eligible compensation to a 401(k), and these contributions are invested in various pre-selected investment options provided by the employer. Some employers may also choose to match employee contributions. If you leave your job, you won’t be allowed to make further contributions to the account.
If you stop contributing to your 401(k), your 401(k) money will continue growing if you leave the 401(k) plan or transfer to another qualified retirement plan. Generally, 401(k) grows through compounding, and the returns earned from investments are reinvested back into the account to earn returns of their own. Over time, the 401(k) money grows to a significant nest egg that you can withdraw to maintain your lifestyle in retirement.
Why stop contributing to 401(k)?
The main reason why you could stop contributing to your 401(k) is when you quit your job or switch to another employer. Once you switch jobs, you will no longer earn a salary from your employer, and this means that your employer will no longer make deductions from your paycheck to fund your 401(k) account.
Once you leave your job, you can decide to leave the 401(k) money with your employer before you figure out what to do with the money. However, the IRS requires that you must have at least $5000 in your 401(k) to be allowed to leave the money behind. If your 401(k) balance falls below $5,000, the employer could force a cashout and send you a check, or transfer the 401(k) money to an IRA of its choice.
As long as your balance remains above $5,000, your employer will continue managing your retirement savings. However, you will no longer receive a 401(k) match from your employer. The money will continue growing through compounding depending on the investments you hold in your 401(k). For example, if you hold stocks in your 401(k), the investments will grow based on the market growth of the stocks.
How 401(k)s grow
How a 401(k) account grows depends on the asset allocation. Usually, you can invest in different types of assets in your 401(k) such as stocks, bonds, exchange-traded funds, and mutual funds, and each of these assets offers different returns. Two employees enrolled in the same 401(k) could experience different levels of returns based on the investments they have in their 401(k).
Generally, an individual with a long time horizon before retirement can hold riskier investments in their 401(k) than an individual nearing retirement. For example, stocks are considered more volatile and riskier, but they have higher expected returns. Stocks are a good long-term investment since you can earn higher returns, and if you lose money, you still have time to recoup your money.
If you are a few years away from retirement, you may want to hold less risky investments in your 401(k). You can invest in less volatile investments such as bonds that earn lower rates of return over time. Switching from stocks to bonds ensures that your investments will continue growing until you start making withdrawals in retirement.
The greatest benefit of saving for retirement using a 401(k) is the compounded growth of 401(k) earnings. The returns generated from investments are reinvested back into the 401(k), and they earn a return of their own. Over time, the compounded earnings on your retirement savings can grow bigger than the contributions you've made over the years.
How much will my 401(k) grow over a 20-year horizon?
Over a 20-year time horizon, your 401(k) can have different growth patterns depending on the scenario. For example, assume that you start with a $0 401(k) balance, and you save 10% of your $50,000 annual salary. You also receive a 401(k) match of up to 3% of your contributions. In addition, you expect to receive a 2% annual salary increase, and an expected annual return of 7%. The expected inflation rate is 3% per year.
By the end of the 20-year time horizon, you can expect your 401(k) balance to increase to $283,724. However, if you start with a 401(k) balance of $50,000 instead of a $0 balance, the 401(k) will grow to $477,209 in 20 years. If the expected return is 8% and you expect the salary to increase by 3% over a 30-year time horizon, your 401(k) balance will grow to $913,193.
Your Options if you leave your job
Once you leave your job, you won’t be able to make further contributions to your 401(k). If you want your 401(k) to keep growing, you have the following options:
Leave 401(k) with your employer
If you have $5000 or more in your 401(k), your employer will allow you to leave your 401(k) money in the plan after you leave. Your money will continue growing in the plan until you start taking distributions in retirement. However, you will still incur 401(k) fees, which will continually eat into your retirement savings.
Rollover to a new 401(k)
If you switched jobs and the new employer has a 401(k) plan, you can choose to rollover the 401(k) into the new employer’s 401(k) plan. Once you are eligible to join the 401(k) plan, you can request a direct rollover from the old employer’s plan to the new employer’s plan to avoid owing income taxes on the transfer.
Rollover to an IRA
If you leave your job for another employer, and the new employer does not have an IRA or you don’t like the investment options, you can decide to rollover the 401(k) into an IRA. If you transfer your 401(k) to Beagle, you get access to a wider pool of investments that you can choose to continue earning investment income. Beagle also unlocks your IRA so that you can borrow against your retirement savings.
