Bloomberg recently did an analysis of the best 401k plans offered by the list of S&P 500 companies. They created a scoring system based on: matching contributions, additional automatic contributions, fund availability, vesting requirements, and automatic enrollment. They also looked at special restrictions such as requiring matching contributions to only be in company stock (this subtracted from the overall score). Overall, it looks like they have a pretty good methodology.
I was amazed at some of the very best 401k plans at the top of the list – check out ConocoPhillips right at the top. There’s some major opportunities for saving up a big chunk of cash for retirement without a lot of sacrifice. It’s almost as if these companies simply shifted their pension obligations over to profit-sharing via 401k matches and contributions. Check out the list of the top ten:
To the astute investor out there it should be no surprise that a lot of the companies at the top of this list pay hefty dividends out to their shareholders. ConocoPhillips, Boeing, McDonald’s, Altria, and Phillip Morris International stand out in particular. However, there are others like Google, who don’t pay a dividend, but have a lot of free cash flow they can give back to their employees. Citigroup barely pays a dividend as of this writing, but that’s likely to increase in the future, especially if interest rates rise.
One thing that came to mind when I looked at this list was thinking about an average employee who had a goal of stashing away a lot of retirement cash – how could they maximize their 401(k) plan? What do you get when you couple significant sums of retirement savings on both the employee’s side and the company’s side? The answer: a lot of money 🙂 But how much is possible? What is the potential here?
Let’s imagine a fictional guy named Treyvon. He’s a smart dude, and he’s 22 years old. He just graduated from engineering school and snagged a job at ConocoPhillips as an entry level reservoir engineer. His starting base salary is around $100,000. Man, look at this guy. Already so young and he’s raking it in.
Being a wise young man, Treyvon decides not only to contribute the 1% needed to get the 401k match from the company, but to max it out entirely. He just got out of college so, what the heck, he’s been living in poverty anyway, what’s $18,000 of unseen money?
At this point let’s look at the breakdown of ConocoPhillips’ retirement package. It looks like they offer:
- 9% match on the first 1% contributed to the 401k
- 6-9% of employee compensation, based on age, placed in a cash account
- a wide collection of stock and bond index funds
- immediate, 100% vesting of all contributions
Let’s assume average 3% raises throughout Treyvon’s career. Let’s also assume that even though the cash account contributions are credited with interest based on the U.S. 30-year Treasury rate, they earned no interest whatsoever so that it is truly a “cash” account. Also, I assume that the full $18,000 contributed each year never increases.
His money compounds at an average rate of 10% annually over a 40 year period, net of fees. I also assumed that all 401k contributions are using the Roth 401k option, which ConocoPhillips offers. Although all company match contributions will be pre-tax, there is still a lot of money that is going to be saved in future taxes, as I demonstrated in this post where I talked about my wife and I’s decision to switch our 401k contributions from pre-tax to Roth.
Here’s what happens after 40 years of consistent contributions and compound interest:
This is possible because of consistent contributions made from both Treyvon and ConocoPhillips over a long period of time. Getting an average of 10% returns helps too, of course, but even if the returns were 5% annually, we’re still looking at over $4,000,000 in 401k wealth. At the end of 40 years, our faithful petroleum engineer will be a decamillionaire.
This doesn’t account for stellar performance on the job, which would mean even higher raises than the 3% assumed. This doesn’t take into account raised limits on 401k contributions over the years. This doesn’t account for interest earned on the cash account.
Treyvon could have never saved another penny. He could have taken the rest of his earnings and, after taxes and basic expenses were accounted for, gone out every weekend for beers with the boys. He could travel to Europe every year. Give large donation checks to his church. Buy a house and comfortably support a family of five.
Ok, ok, you get it. If you’re reading this, you’ve likely heard some version of it before. Save lots of money and do it as early as possible and eventually you’ll wake up with boatloads of cash. But what about an extreme case? What if we pushed the limits of our assumptions even further? What if our fictional engineer, at the age of 21, looked at his life and decided to tweak all of the variables he could in order to ensure the highest amount of wealth in his 401k account at 60 years old?
Let’s adjust our assumptions. Let’s say there are 5% raises because of hard work and recognition among our guy’s management. This will directly affect the company match as well as the amount contributed to the cash account over time. Let’s also assume that the 401k contribution limits rise $500 every year. This is typically in line with what has happened historically. Here’s what happens to the numbers:
That’s almost an extra $4,000,000. Those increased IRS contribution limits make a difference. Higher salaries over time make a difference. Sometimes people complain because of seemingly small 2% or 3% raises at work, or maybe even shrug at the thought of the IRS increasing annual contribution limits by a whopping $500 per year.
I get it, I’ve been there. But there are many worse things in life. That seemingly small increase in income and seemingly small increase in tax-sheltered contributions means real wealth over long periods of time. That extra $4,000,000, given an average dividend yield of 3%, could be pumping out an extra $120,000 per year in passive income. Just as in the lesson of compound interest we cannot despise the day of small beginnings, neither can we be ungrateful for the days of small pay or savings increases. Over time, they really do make a difference.
Let’s summarize the list of advantages that made this $18.6 million 401(k) account possible:
- To start, make as much money as possible, maybe even six figures, right out of college in order to provide investment capital.
- Work for a company that has a generous matching program, and maximize it’s benefits.
- Maximize the IRS guidelines for contribution limits.
- Utilize a Roth 401(k) if it is available to significantly cut future tax liability (matching contributions will still be taxed under current rules).
- Invest every year without fail, and without taking loans out of the account and ignoring market fluctuations.
- Utilize low-cost index funds in the 401(k) in order to reduce fees.
By stacking advantage on top of advantage, before long a lollapalooza effect occurs, where you have multiple various reinforcing each other, which results in exponential returns over time. Although this is great in an ideal world, the first example proves that you don’t have to get everything right to have outstanding results. Just putting together a few key variables can make things work out just fine. Here, the most important variables are the high starting salary, the generous matching program, and the passage of time. The other variables simply amplify the results further.
I was excited to write about this case study because it helps psychologically reinforce decisions my wife and I are making in our own lives. Over time, habitually making small good decisions can yield fruitful results, and it’s one of the reasons I’ve grown to love the process of investing.