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JEFF BEZOS ONCE asked Warren Buffett why everyone doesn’t just copy his example when investing. Buffett famously replied, “Because nobody wants to get rich slowly.”
The magic of saving diligently, coupled with decades of compounding inside tax-advantaged accounts, can ensure financial freedom. In fact, young married couples today have an outside chance of accumulating $10 million by the time they reach the new required minimum distribution age of 75.
To reach the $10 million jackpot, a couple would both have to save the maximum allowed in their 401(k) or 403(b) from age 22 to 62, plus earn a 4.5% average annual return on that money from age 22 to 75. Hard to fathom? Here’s the math behind their fortune.
In 2023, workers can contribute a maximum of $22,500 per year to tax-deferred plans, which would translate to $900,000 of total contributions over a 40-year career. Assuming a 4.5% annual return, the contributions would grow to be worth $2.5 million at age 62.
Many workers also receive a company match on their contributions. Let’s assume a 3% match on $60,000 of annual earnings. This adds another $1,800 a year, or $72,000 over 40 years. With a 4.5% annual return, the company contributions would grow to be worth $201,000 at age 62.
Starting at age 50, workers can add $7,500 in catch-up contributions to their tax-deferred plans. Twelve years of catch-up contributions add another $90,000 to the savings pot. With a 4.5% annual return, that would grow to be worth $121,000 by 62.
If you’re keeping score at home, this means a determined worker can build up a nest egg of nearly $3 million in their tax-deferred accounts by age 62. But wait, there’s more.
Let’s presume retirees can live on other savings and Social Security until they begin taking required minimum distributions at age 75. That means their retirement savings can compound tax-deferred for a further 13 years, from age 62 until 75. At our constant 4.5% growth rate, their $3 million balance would grow to $5 million.
If each member of a couple followed such a diligent savings strategy, their combined retirement pot would be worth $10 million at age 75. Now comes the reward. Each one would need to take required minimum distributions of $205,000 beginning at age 75, or $410,000 annually as a couple.
With income that high, their federal tax rate would be solidly within the 32% bracket, and perhaps 35% if Social Security payments and other income were added in.
In effect, their $10 million balance is $6.6 million of after-tax wealth, and even less in states that tax retirement account distributions. In addition, their required distributions would push the couple into the second-highest Medicare income-related monthly adjustment amount (IRMAA) bracket, which would increase their Medicare Part B and Part D premiums over the base level by about $10,400 per year, based on 2023’s surcharges.
How realistic is this scenario? Well, the savings rate used in this analysis is quite high, particularly for young adults just starting out. Few couples will be able—or want—to put aside $45,000 per year in savings, especially if they’re early in their careers, with each earning just $60,000 a year. On the other hand, many of the other assumptions are relatively conservative.
The 4.5% annual return, for example, is moderate. The stock market has delivered 10% annual returns over the past 40 years, and today short-term bonds pay nearly 4.5%.
Neither the contribution limits nor the couple’s incomes are adjusted for inflation, as would happen in real life. Further, I also used simple annual compounding rather than continuous returns. Finally, the taxes on their distributions will increase substantially if the 2017 tax law is allowed to sunset as scheduled in 2026.
I wouldn’t predict a large number of young couples will get to $10 million. Yet it’s useful to know that diligent super-savers with successful career paths can save a small fortune if they choose. And, as night follows day, they would also face some surprisingly high tax rates, with IRMAA layered on top.
This high-tax scenario could also apply to anyone receiving a significant inheritance or substantial outside income. My recommended remedy for anyone on one of these three fortunate paths is to “Roth early, Roth often.” That should help keep the taxman at bay.
John Yeigh is an author, speaker, coach, youth sports advocate and businessman with more than 30 years of publishing experience in the sports, finance and scientific fields. His book “Win the Youth Sports Game” was published in 2021. John retired in 2017 from the oil industry, where he negotiated financial details for multi-billion-dollar international projects. Check out his earlier articles.
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I think it’s safe to say that the majority of readers of HD are significant savers.
But if one is worried about the following statement, “With income that high, their federal tax rate would be solidly within the 32% bracket, and perhaps 35% if Social Security payments and other income were added in.” It might sound like heresy, but I suggest one way to decrease their tax rate in retirement may be to be a little LESS frugal and enjoy spending a little bit more before retiring and required RMDs kick in, thus reaping the benefits of their labor.
I am curious, can someone estimate what kind of income and savings rate a 22 year old needs earn to have to save $22500/year in a 401K? Forty some years ago when I started working, saving 15% of your income was considered a great a savings rate. One has to earn $150K/yr to save $22.5/yr if the 15% savings rate is used. Various articles on the web indicate the average income of a twenty year old is closer to $50K/yr.
Please recognize I am not knocking the concept of saving as much as you can as early as you can, but I think this article might have more appeal to younger folks if the numbers used were more in line with the world our twenty year olds live in.
Great article, John! It was a much needed encouragement that slow and steady wins the wealth accumulation race.
When listing the various ways one could max out their 401k account, I believe you left out a large additional source of tax-advantaged contributions: the in-place Roth conversion. Here’s a quick personal example to illustrate this:
Now I know that not every 401k plan allows in-place Roth conversions, so this isn’t an option for everyone. But I thought it’s worth highlighting because it can allow one to effectively double the amount of money they’re contributing to their 401k.
Whoa, what? I wonder if Fidelity (which administers both my and my husband’s plans) does this!
Austin – thanks for sharing this solid strategy for building up not only your 401k tax-deferred account, but also your Roth account. You are clearly a super-saver which may be particularly beneficial with the low tax rates from the 2017 legislation.
As the article demonstrates, saving large amounts within tax-deferred accounts can lead to high untaxed wealth, and also high tax and IRMAA rates when RMDs begin. It appears your company provides a match all the way up to your maximum contribution which is a generous match. For those workers who get the maximum company match below their maximum contribution, they may want to consider backing off their late-career contributions to the match once their tax-deferred accounts reach a few million dollars if their RMD plus IRMAA tax costs look likely to be higher than their tax cost now.
Couple of things:
1) Inflation over the course of 50+ years will mean $10 million is not worth nearly as much as it is today.
2) We do not know what the allowable contributions will be increased to over the course of the next 50+ years.
Hi Nate,
Regarding your point #1, I looked at the assumed 4.5% rate of return as a “real” rate of return (after inflation). I think over a 50+ year timeframe it is not unreasonable to assume a 4.5% annual return above inflation.
Therefore, I view the $10 million figure as being in “today’s dollars”.
This shows once again the power of time. If we are lucky enough to have it in ample supply.
John, great article. Strong takeaway’s for me as an individual in my mid twenties getting married this summer. I think the most valuable takeaway of all is just do it. Its not hard to accumulate wealth if you use the tools at your disposal and put in some effort.
Gavin – thank you for the positive feedback from someone just getting started. My two children are also in their mid twenty’s, have had Roth accounts since their earliest teen jobs, and are starting to see some real growth now 7 and 12 years later. They have become believers in the magic of longer-term compounding.
John, this is a great article for anyone, but especially a younger reader, or to pass along to a new, young reader. I’m a late starter with investing, so I’m just mid-way through my third decade of witnessing the power of compounding. I am still amazed.
If you understand the Rule of 72 and save early and often and especially in tax deferred, you will create wealth at retirement. Just Read Bogle
But could they contribute those dollars as a percentage of income in a plan? Would a plan permit it? Looks like about 35% of pay.
I contributed high percentages (25-35%) of pre-tax income to my retirement plans, especially in my later working years. Contributions with employer match went to a regular retirement plan and those without match went to a “supplemental” retirement plan.
In retrospect, contributing the extra money to a Roth might have been wiser. Supplemental plans, in comparison to regular plans from the same firm, had higher fees overall and lower rates in funds with fixed income. But then, taxes always would seem high at the time, and a dollar saved from taxes was a dollar that I would not otherwise have invested. I’m still satisfied with having done this, even now with higher tax brackets and IRMAA. (Good problems to have!)
Yes indeed, up to 100% is possible per the IRS:
“The annual additions paid to a participant’s account cannot exceed the lesser of:
100% of the participant’s compensation, or$66,000 ($73,500 including catch-up contributions) for 2023″https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits
The article admits an extraordinary savings rate for young couples, but this could be readily offset by a higher earnings rate than 4.5% which is rationally possible.
Yes, but do plans actually permit such high percentages? No matter, your point is still valid. Saving is still possible even beyond the 401k.
Mine does. They follow the IRS rules.
Yes, the magic of compounding for super-savers holds even if contributed to an after-tax account. In fact, there is a potential tax arbitrage benefit as the marginal tax rate on $120K less $27.7K deduction would only be 12% if just $3K is contributed to a tax-deferred account, let alone the $45K.