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The Most Important Thing to Know About Your 401(k)

Don't fall for the 'wealth illusion' — figure out how much your plan might provide in monthly retirement income

By Richard Eisenberg

If you’re one of the 51 million Americans putting money into a 401(k) or have a plan from a previous job, here’s a question: How much would it provide in monthly income when you retire?

I bet you don’t have a clue.

But you really should know the answer — and in a bit I’ll show you how to determine it.

More Important Than Knowing Your 401(k) Fee

I actually think your 401(k) plan's monthly retirement income figure (part of what Fidelity Vice President Jeanne Thompson calls your “retirement paycheck”) is the most important number of all — more important than its annual fee, rate of return or the total amount you’ve saved, though those are vital to know, too.

(MORE: Watch Out: Your 401(k) is Being Targeted)

“The lump sum in your 401(k) may seem like a lot, but when you translate it into a monthly income stream over 20 or 30 years, it may not be as much as you think,” Thompson says. “Breaking it down into how much the money will provide will give you a much better picture of how much you’ll have to spend in retirement.”

In Retirement, Cash Flow Is King

As I noted in my blog post about financial independence, when you’re in your 50s or 60s, planning for retirement isn’t about The Number; it’s about figuring out your cash flow once you stop working full time.

Financial adviser Erin Botsford, author of The Big Retirement Risk: Running Out of Money Before You Run Out of Time, put it well in an a Next Avenue article about making your money last: “Your No. 1 objective should be to secure enough predictable income to sustain your basic needs and satisfy your lifestyle.”

The Wealth Illusion

The problem with just seeing your 401(k) as a single five-digit, six-digit or even seven-digit figure is that it creates what economists call “the wealth illusion.”

As a U.S. Labor Department official told me: “People look at their 401(k) benefits statement and see they have 60,000 bucks in there and they think they’re rich.” But $60,000 won’t provide much spending money in a retirement lasting 20 or 30 years.

“For some people, seeing what their 401(k) would mean in terms of monthly income will be a wake-up call,” says Christine Fahlund, a senior financial planner and vice president of T. Rowe Price Investment Services.

A Powerful Incentive to Save More

There’s now proof that seeing the monthly estimate could well be an eye-opener that convinces you to save more for retirement.

The Principal Financial Group found that 401(k) participants who know the monthly income translation save 46 percent more than those who don’t.

Another recent study discovered that workers who changed their 401(k) contributions after receiving brochures with retirement income forecasts invested $1,150 more a year than those who didn’t receive the information. “We were somewhat surprised,” the study’s co-author, Gopi Shah Goda, a senior research scholar at the Stanford Institute for Economic Policy Research, told me. “Financial education normally tends to have a small effect on savings.”

Most 401(k) Plans Don’t Tell You

The trouble is, 401(k) statements rarely show employees how their savings would translate into monthly income.

According to a 2012 MetLife report, only 33 percent of plan sponsors include retirement income projections on their participants’ statements; just 28 percent show the figures automatically when employees view their balances online. In fairness, 82 percent of plan sponsors offer a “do it yourself option,” allowing 401(k) investors to run the numbers themselves online. But very few people take the trouble.

(MORE: To Tap Your IRA or Not? That’s the Question)

A Good Tool, if You Can Get It

I’m especially impressed with the Income Simulator online calculator Fidelity recently started offering to employees in all the 401(k) plans it manages, to help them derive the monthly figure. It takes about five minutes to use, Thompson says, somewhat longer if you want to add in numbers for your spouse or partner.

The Fidelity Income Simulator estimates how much your 401(k) would provide in monthly income based on how much you’re contributing and when you plan to retire. You can also add in money you have in IRAs and other savings as well as what you’re likely to receive from Social Security. The Income Simulator also lets you see what you’d get each month by altering factors such as your retirement date, the amount of your contributions, your investment choices and how long you’ll live.

How Washington Might Help Out

For 401(k) participants whose plans don't provide this type of tool or information, however, Washington may be coming to the rescue.

The U.S. Department of Labor recently proposed requiring employers to include in their 401(k) statements the monthly income that plan participants could expect to receive over their lifetimes. It would be similar to what federal employees already see in their Federal Thrift Savings Plan statements and what Social Security says you can expect to receive in its monthly retirement benefits if you create a My Social Security account online.


“Retirees run the risk of outliving their savings,” said Phyllis Borzi, assistant secretary for employee benefits security, in a written statement about the proposal. “If workers have the benefit of seeing how long their savings could last, it might spur better planning for the future.”

Try the Government’s Online Calculator

The Labor Department’s requirement won’t take effect before next year, if ever; the agency is just soliciting input on the idea right now. But the Labor Department has a free Lifetime Income Calculator on its website you can use now to see how much your 401(k) might deliver in monthly income.

I tested it out using a hypothetical example of a 55-year-old employee with $500,000 in a 401(k) who contributes $10,000 a year and plans to retire at 65.

According to the calculator’s estimate, the plan would provide $4,813 a month in lifetime income. If that employee were, instead, 60 and retired at 65, the monthly income would shrink to $3,717. And if the 55-year-old had $1 million in the 401(k), the monthly income would be $8,885.

What a New Law Would Do

There’s also bipartisan legislation before Congress, known as the Lifetime Income Disclosure Act, which would require 401(k) providers to include monthly lifetime income estimates in their annual statements to employees.

The bill’s sponsors — in case you want to offer them your support — are Senators Johnny Isakson (R-Ga.) and Christopher Murphy (D-Conn.) and Representatives Rush Holt (D-N.J.), Ron Kind (D-Wis.), Dave Reichert (R-Wash.) and Tom Petri (R-Wis.)

A Helpful Free Online Calculator

For now, though, if your 401(k) doesn’t provide a monthly income estimate, your best bet is to use a free online calculator.

I’m partial to the T. Rowe Price Retirement Income Calculator because it’s simple, straightforward and extremely helpful.

With this tool, you say how much money you’d like to live on annually in retirement and the tool shows whether your retirement income sources will do the trick. Like the Fidelity calculator I mentioned, the T. Rowe Price version lets you plug in various assumptions and see how the results would affect the amount your retirement savings would deliver in monthly income.

“We’ll tell you how much you can afford to spend with an 80 percent chance of not running out of money before 95,” Fahlund says.

Whether you use an online calculator or get monthly income numbers from your employer, just remember that the figures you see will be estimates.

Should You Buy a 401(k) Annuity?

One last point on this subject: Be cautious if your employer lets you convert your 401(k) into an annuity with a monthly income stream.

While the cost would likely be lower than if you rolled your plan into an IRA and then bought an annuity on your own, you shouldn’t put your entire 401(k) into an annuity. Otherwise, all the cash will be parceled out in fixed amounts that you can’t raise or lower.

As Fahlund points out, “You need the flexibility so you can tap into your nest egg for expenses that come down the pike during retirement, like a new roof or a refrigerator.”

Photograph of Richard Eisenberg
Richard Eisenberg is the former Senior Web Editor of the Money & Security and Work & Purpose channels of Next Avenue and former Managing Editor for the site. He is the author of "How to Avoid a Mid-Life Financial Crisis" and has been a personal finance editor at Money, Yahoo, Good Housekeeping, and CBS MoneyWatch. Read More
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