Almost no one accidentally becomes a millionaire. There are a few who inherit a fortune and become millionaires without any effort, but for the rest of us, becoming wealthy requires purposeful action. But it requires less purposeful action if you simply automate the process.
As you know from my real estate investing story, after I automated my real estate investments, managing my 64 rental units required very little of my time as a full-time general surgeon (A couple of hours a week). My course on Automating Your Real Estate Investments explains in detail the steps I took to make my rental real estate run smoothly, without taking much of my time.
Now, I want you to understand the power of automating your retirement plans so you can retire a multimillionaire with even less effort than I put into my real estate. In fact, the effort will be zero minutes a year once your retirement investments are completely automated. So who wants to be a millionaire? Just about everyone.
It all starts with your primary job. Almost all professionals have some sort of retirement plan with their employer. In the example I will present, we will assume your employer offers a traditional 401(k) retirement savings plan and you are an employee of the company. This will include almost every W-2 physician in America. If you own the company you work for, (a private practice physician) you can put away even more money than this example shows.
The current maximum annual deposit into a 401(k) is $19,500, which is $1,625 a month before taxes. If you were to take that $1,625 each month as salary, after paying the taxes you might end up with about $1,000 a month to spend. So, maximizing your 401(k) every month gives you about $1,000 less in your pocket to spend now, but gives you a $1,625 deposit into your retirement plan. Immediately this gives you the equivalent of a guaranteed instant 62.5% return on your investment. You can’t safely get that kind of return anywhere. The return is even higher if your company has an employer match program.
To sign up for your company’s retirement plan, talk with the person in charge of payroll and tell them you want to contribute the maximum amount to your retirement plan. After filling out their paperwork, the payroll department will take care of the details to get your retirement account set up and working. Once your account has been set up, it will stay in place until you ask the payroll department to make a change. The best time to start maximizing your company retirement plan in now. There is no time to waste when compound interest is at stake.
Sometimes, however, there is a waiting period before you are eligible to participate in the company retirement plan. If so, put the date you are eligible into your calendar and stop by the payroll department on that date to get the ball rolling as soon as possible.
Once you have signed up for a plan, you must choose where the money will be invested. Although every plan has different choices available, make sure you invest in an index fund that has a broad group of US stocks. If you can’t decide which index fund best meets this criteria, ask for help. There is likely someone assigned to help you make this decision. Start with one fund. Later, if you want you can add another fund, but one is enough to get started.
So, what are the effects of this simple move that may have taken up an hour of your time? It depends on when you started the automation process and when you start living on the funds. If you made this move at age 30 and you plan to work as a physician until you reach the age of 65, then you will have 35 years for this automation to work its magic through compounding.
The average long term investment return for the stock market is an annualized 8-10 percent. If your investments returned 8% over this period, you would have $3,752,409.43 at your retirement. If you got the higher 10% return, you would have $6,220,949.64. If we play this conservatively, you will likely have more than $4M when you retire, if you have no other retirement savings. All that for one hour of your time when you start your job at age 30.
If you use the 4% rule while you are retired, your retirement withdrawals would be $160,000 a year or 13,333 a month. You invested the spending power of $1,000 a month while you were working, and you retired with $13,333 income a month for the rest of your life. That is a pretty good trade. But there’s more.
Now do the same with your IRA account. Let’s say you are married, and you and your spouse can each contribute $6,000 a year to an IRA account, for a total of $12,000 a year or $1,000 a month after taxes. Your tax bracket, as a physician, will likely be too high to get the IRA tax deduction for your contribution or to qualify for a Roth IRA.
Your contribution will, therefore, be a non-deductible traditional IRA deposit. Currently the law allows you to roll this money into a Roth IRA. This is called a backdoor Roth IRA. But congress is talking about eliminating that option.
Automate this investment by setting up a brokerage account for each of your IRAs at a brokerage firm such as Fidelity, Vanguard, Schwab or TD Ameritrade and establish a monthly automated transfer from your checking account of $500 to each of your IRA brokerage accounts.
This additional $1,000 every month compounded at 8% for 35 years comes to $2,309,175.03. If you earned 10% it comes to $3,828,276.7. Using the $2.3M figure and applying the 4% rule upon retirement means you can pull out an additional $92,000 a year or $7,666.67 a month during your retirement years.
This is a trade of $1,000 a month in spending power while you are working for $7,667 a month for your entire retired life. Another great deal.
When you automate these two retirement savings plans, upon retirement you will have accumulated a total of $6.3M in retirement funds. You can live out your retirement taking $252,000 a year for the rest of your life without doing anything beyond the initial setup. You have become an automatic multimillionaire.
During your working years, $31,500 a year was automatically contributed to your retirement accounts and during your retirement years you will be collecting $252,000 a year, unless of course you end up with an average return that exceeds 8%. I have been a fairly conservative investor since I opened my first IRA investment in 1989. Thirty-two years later, my total market return has been greater than 10% and I have lived through two big market crashes: the 2001 dotcom bubble burst and the 2008 financial crisis.
You can save even more if you make one more trip to the payroll officer when you turn 50. At that time you are allowed to contribute a catchup amount which is an extra $6,500 a year into your 401(k) and $1,000 a year into each IRA account. That extra $8,500 a year will boost your retirement numbers even more.
In reality, Congress will keep changing the amounts you can contribute and you will want to make the necessary changes to stay at the maximum allowable contribution, but you don’t have to since the current numbers should meet your retirement needs. This might add another hour of your time periodically.
I love the concept of automatically becoming a millionaire. What about you? I would love to hear from anyone who has done this and is now retired living off their nest egg like I am. If you want more information on retirement, pick up a copy of The Doctors Guide to Smart Career Alternatives and Retirement.
Of course the income is pre-tax! Isn’t ALL income pre-tax?
In general, I agree with you regarding the automatic deposits into these a 401 K and Backdoor Roth IRA. But whether you make 8 or 10% on your 401K, you will not be getting the whole amount at your disposal since you have not paid any taxes on them. Therefore, your calculation of receiving $252K (401 K and Roth IRA distributions) per year is overestimated.
Richard, Yes these numbers are gross, before taxes. Since taxes are based on other income and what state you are in, it will vary widely so I didn’t include them here. The Roth IRAs will not be taxed and the 401(k) will be.
Yes, he forgot to account for taxes. If you put in pre-tax money, Uncle Sam will get what is coming to him later. Would you rather him take his cut from the seeds or from the harvest? Either way it is the same. However, I expect in retirement your income tax rate will likely be higher, due to the Government’s growing debt problem and spending addiction. This is unless you plan to retire poor, depending on Government handouts. However, who wants to plan on that?!?
The above example of compounding can be accomplished outside of a qualified retirement plan. The 401k just limits your options. Yes, it is an automated method for those not wanting to put any effort in. However, for those willing to spend a little effort, better returns exist outside of those plans.
Darrell, I would not say you can get better investment returns outside of retirement plans. Retirement plans are only an account you keep the money in so it can be segregated and not taxed until you take it out. That doesn’t lessen returns, it boosts them. For high income earners, the initial tax benefit creates a huge first year return that can’t be found investing in after tax accounts. There are some restrictions, designed to encourage you to keep the money there until you retire. It won’t help you if you spend the money on stuff before you reach retirement.