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Secrets of the 401(k) Millionaires

Those hoping to occupy Easy Street in retirement may want to follow the lead of the 0.2%: the topmost tiny fraction of savers who've managed to sock away more than $1 million in their 401(k)s.

That figure, based on data from the Employee Benefit Research Institute, may depress those with sums closer to the median 401(k) balance of roughly $60,000 -- and for good reason. Even among employees 55 and up who've been contributing to the same 401(k) plan for more than 20 years, just 2% are estimated to have cracked the $1 million mark, says Jack VanDerhei, EBRI's research director.

To some, the other 98% of savers over 55 who haven't cracked $1 million show that the 401(k), the principal vehicle for American retirement savings, is at best inadequate, and at worst, a colossal failure. Even Ted Benna, the man credited with developing the first 401(k) plans out of an IRS tax loophole in 1981, now concedes that they've grown overly complex, with too many options, too high fees, and too many ways to cash out one's nest egg.

Even some 401(k) providers don't disagree. With traditional pensions, employers hired teams of experts to make the kind of tough investing decisions now entrusted to individual employees, says Catherine Golladay, vice president of participant services for Charles Schwab. "Left to their own devices, most people do not have the knowledge or the discipline to do this themselves," she says.

Schwab, like other 401(k) providers, found efforts to educate employees haven't proven so successful -- and only 10% of workers take advantage of such offerings. So the company just announced a new index-fund-only 401(k), which will keep expenses down, and include mandatory advice on investments. "Many employees don't understand what they are losing to expenses -- sometimes 55 to 110 basis points," says Jim McCool, an executive vice president at Schwab. "They don't realize what a drag it is on their retirement savings."

Target-date funds, which allocate investments based on the saver's age have proven inadequate, McCool says. "It's a cookie-cutter, one-size-fits-all approach. We're hoping that by adding independent, one-on-one advice we can help tailor plans to the needs of individuals and stop them from panicking and making bad decisions when the market gets scary."

So if that's what's wrong with the 401(k), who are these super-rich among retirement savers who've managed to make the system work -- and what are they doing differently? They don't necessarily have higher than average salaries or the investing IQ of Warren Buffett, VanDerhei says. "The one characteristic that differentiates the winners from the non-winners here is contribution rate -- a high percentage of those million-dollar savers had constant participation and high contribution rates," he says.

Though many savers may be scarred by the past decade of lousy returns, getting to $1 million over the course of a 40-year career should be a manageable goal -- even for some lower-income employees, says Greg Burrows, vice president of Principal Financial. Someone who earns $35,000, saves 12 to 13%, including a company match, gets an annual raise of 3.5%, and annual returns of 7% would save a million dollars. And despite the current volatility, many may still do that, he says. "One thing you have to keep in mind, is that the 401(k) hasn't been around long enough for us to see people take full advantage of it over the course of an entire career."

Of course, those who earn big salaries are more likely to have big balances in their 401(k), says Mike Alfred, CEO of Brightscope, which monitors and rates retirement plans. And the recession not only wiped out many 401(k) balances, but its fallout has hampered saving -- particularly among the middle class, he says. "There are a lot of families who have to simply stop saving because of a job loss or major health-care issue," he says.

And top of that, most participants can't -- or don't -- take advantage of their 401(k), says Alfred. Advisers recommend savers max out their 401(k) contributions. But while the IRS raised the cap $500 to $17,000 for 2012, just 9% contribute that much, according to EBRI.

And to put $1 million in perspective: as nest eggs go, it's not exactly Faberge. The rule of thumb, advisers say, is to accumulate enough to be able to replace 75% to 80% of one's income in retirement, without -- ideally -- having to draw down more than 5% of the balance per year. So a $1 million nest egg would give off just $50,000 annually, enough to replace 75% of the income of someone who made $66,666. Even if the retiree collects the current maximum Social Security payment of $30,156 annually for a total income of $80,156, that's still just the recommended replacement for an income of $106,874.

The IRS says it doesn't keep data on the highest 401(k) balances, and providers of the plans refused to disclose the figures. Anecdotally, however, advisers say it's not uncommon for savers to rack up balances in the $3 million to $5 million range.

Bedda D'Angelo, president of Fiduciary Solutions in Durham, N.C., says one of her clients amassed $6 million in her 401(k). An executive at a pharmaceutical company, she maxed out her pre-tax contributions each year, and including after-tax contributions saved close to 30% of her earnings annually. She was the kind of person who never had debt -- not even mortgage debt, D'Angelo says. "She was a disciplined saver, whenever she got a bonus -- she would invest half of it." Her plan had a mix of large cap, small cap, international equities -- and a bit of bonds, and at 56, when she retired, she was earning $450,000.

Another client who saved more than $1 million worked his entire career at General Electric, invested only up to the company match, but entirely in company stock, D'Angelo said. Though such a strategy seemed dangerous -- even before the collapse of Enron, when many employees suddenly found themselves holding worthless shares -- the employee refused to be convinced to diversify, she says. "As soon as I met him, I tried to convince him not to, but he wouldn't hear it," she says.

Other advisers also shared tales of employees making millions with only company stock in their plans. "Those who bet the entire house on a particular stock are always going to have a higher probability of a big win, but they also may end up in big trouble," VanDerhei says.

Kathleen Campbell, an adviser with Campbell Financial Partners in Ft. Myers, Fla., says the handful of her clients who've saved in between $1 and $2 million in their plans all maxed out their contributions, and refrained from jumping in and out of investment selections based on the whims of the market. But she also had clients get rich on company stock, which she also discourages. "Best not to be holding the bag with your retirement savings in another Enron or Bear Stearns," she says.