MONEY retirement planning

How to Make Sure Your Retirement Adviser Is On Your Team

two people the same bike
Claire Benoist

A new rule would require financial advisers to act solely in their clients' best interest when giving retirement advice. Until that happens, here's how you can protect yourself.

In a move aimed at improving consumer protection for investors, the U.S. Labor Department today proposed a rule that would reduce conflicts of interest for brokers who advise on retirement accounts.

The proposed rule would require brokers to act solely in their clients’ best interests when giving advice or selling products related to retirement plans, including 401(k)s or IRAs.

Conflicted advice has been a longstanding problem for anyone nearing retirement—a parade of financial advisers will line up to help you roll over your 401(k) into an individual retirement account. And all too often, the guidance you get may improve your adviser’s returns more than yours.

A report issued in February by the Council of Economic Advisers found that conflicted financial advice costs retirement investors an estimated $17 billion a year. That’s why President Obama announced his support for the proposal back in February.

The new rule would require brokers to follow what is known as a fiduciary standard, which already applies to registered investment advisers. In contrast to RIAs, stockbrokers—who may go by “wealth manager” or some other title—follow a less stringent “suitability” standard, which lets them sell investments that are appropriate for you but may not be the best choice.

Many brokers do well by their customers, but some don’t. “A broker might recommend a high-cost, actively managed fund that pays him higher commissions, when a comparable lower-cost fund would be better for the investor,” says Barbara Roper, director of investor protection for the Consumer Federation of America.

During the next 75 days, the rule will be open to public comments. After that, the Labor Department is expected to hold a hearing and receive more comments. After that, the rule could be revised further. And it’s not clear when a final rule would go into effect—perhaps not before Obama leaves office.

An earlier Labor Department measure was derailed in 2011 by Wall Street lobbyists, who argued it would drive out advisers who work with small accounts. The new measure carves out exceptions for brokers who simply take orders for transactions. It also permits brokers to work with fiduciaries who understand the nature of their sales role.

Securities and Exchange Commission chairwoman Mary Jo White has also announced support for a fiduciary standard that would protect more individual investors beyond just those seeking help with retirement accounts. And the New York City Comptroller recently proposed a state law that would require brokers to tell clients that they are not fiduciaries.

Until those measures take effect—and even if they do—protect your retirement portfolio by following these guidelines:

Find out if you come first. Ask your adviser or prospective adviser if she is a fiduciary. A yes doesn’t guarantee ethical behavior, but it’s a good starting point, says Roper.

Then ask how the adviser will be paid. Many pros who don’t receive commissions charge a percentage of assets, typically 1%. Some advisers, however, are fiduciaries in certain situations but not all. So ask if the adviser is compensated in any other way for selling products or services. “You should understand what the total costs of the advice will be,” says Fred Reish, a benefits attorney with Drinker Biddle.

Many RIAs work with affluent clients—say, those investing at least $500,000—since larger portfolios generate larger fees. That’s one reason other investors end up with brokers, who are often paid by commission. Have a smaller portfolio? Find a planner who will charge by the hour at GarrettPlanning.com or findanadvisor.napfa.org (select “hourly financial planning services”). Your total cost might range from $500 for a basic plan to $2,500 or more for a comprehensive one.

Beware a troubled past. Any financial professional can say he puts his clients’ interests first, but his past actions might contradict that. To see whether a broker has run afoul of customers or regulators, inspect his record at brokercheck.finra.org. RIAs, who are regulated by the SEC and the states, must file a disclosure form called ADV Part 2, which details any disciplinary actions and conflicts of interest; you can look it up at adviserinfo.sec.gov.

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Favor a low-cost approach. A fiduciary outlook should be reflected in an adviser’s investment choices for you—and their expense. “Before making any recommendations, your adviser should first ask how your portfolio is currently invested,” says Mercer Bullard, a securities law professor at the University of Mississippi. Your 401(k) may have low fees and good investment options, so a rollover might be a bad idea.

If the adviser is quick to suggest costly, complex investments such as variable annuities, move on. “Most investors are best off in low-cost funds,” says Bullard. And with so much at stake, you want an adviser who’s more concerned with your costs than his profits.

Read Next: Even a “Fiduciary” Financial Adviser Can Rip You Off If You Don’t Know These 3 Things

MONEY Ask the Expert

Which Wins for Retirement Savings: Roth IRA or Roth 401(k)?

Ask the Expert Retirement illustration
Robert A. Di Ieso, Jr.

Q: I am 30 and just starting to save for retirement. My employer offers a traditional 401(k) and a Roth 401(k) but no company match. Should I open and max out a Roth IRA first and then contribute to my company 401(k) and hope it offers a match in the future?– Charlotte Mapes, Tampa

A: A company match is a nice to have, but it’s not the most important consideration when you’re deciding which account to choose for your retirement savings, says Samuel Rad, a certified financial planner at Searchlight Financial Advisors in Beverly Hills, Calif.

Contributing to a 401(k) almost always trumps an IRA because you can sock away a lot more money, says Rad. This is true whether you’re talking about a Roth IRA or a traditional IRA. In 2015 you can put $18,000 a year in your company 401(k) ($24,000 if you’re 50 or older). You can only put $5,500 in an IRA ($6,500 if you’re 50-plus). A 401(k) is also easy to fund because your contributions are automatically deducted from your pay check.

With Roth IRAs, higher earners may also face income limits to contributions. For singles, you can’t put money in a Roth if your modified adjusted gross income exceeds $131,000; for married couples filing jointly, the cutoff is $193,000. There are no income limits for contributions to a 401(k).

If you had a company match, you might save enough in the plan to receive the full match, and then stash additional money in a Roth IRA. But since you don’t, and you also have a Roth option in your 401(k), the key decision for you is whether to contribute to a traditional 401(k) or a Roth 401(k). (You’re fortunate to have the choice. Only 50% of employer defined contribution plans offer a Roth 401(k), according to Aon Hewitt.)

The basic difference between a traditional and a Roth 401(k) is when you pay the taxes. With a traditional 401(k), you make contributions with pre-tax dollars, so you get a tax break up front, which helps lower your current income tax bill. Your money—both contributions and earnings—will grow tax-deferred until you withdraw it, when you’ll pay whatever income tax rates applies at that time. If you tap that money before age 59 1/2, you’ll pay a 10% penalty in addition to taxes (with a few exceptions).

With a Roth 401(k), it’s the opposite. You make your contributions with after-tax dollars, so there’s no upfront tax deduction. And unlike a Roth IRA, there are no contribution limits based on your income. You can withdraw contributions and earnings tax-free at age 59½, as long as you’ve held the account for five years. That gives you a valuable stream of tax-free income when you’re retired.

So it all comes down to deciding when it’s better for you to pay the taxes—now or later. And that depends a lot on what you think your income tax rates will be when you retire.

No one has a crystal ball, but for young investors like you, the Roth looks particularly attractive. You’re likely to be in a lower tax bracket earlier in your career, so the up-front tax break you’d receive from contributing to a traditional 401(k) isn’t as big it would be for a high earner. Plus, you’ll benefit from decades of tax-free compounding.

Of course, having a tax-free pool of money is also valuable for older investors and retirees, even those in a lower tax brackets. If you had to make a sudden large withdrawal, perhaps for a health emergency, you can tap those savings rather than a pre-tax account, which might push you into a higher tax bracket.

The good news is that you have the best of both worlds, says Rad. You can hedge your bets by contributing both to your traditional 401(k) and the Roth 401(k), though you are capped at $18,000 total. Do this, and you can lower your current taxable income and build a tax diversified retirement portfolio.

There is one downside to a Roth 401(k) vs. a Roth IRA: Just like a regular 401(k), a Roth 401(k) has a required minimum distribution (RMD) rule. You have to start withdrawing money at age 70 ½, even if you don’t need the income at that time. That means you may be forced to make withdrawals when the market is down. If you have money in a Roth IRA, there is no RMD, so you can keep your money invested as long as you want. So you may want to rollover your Roth 401(k) to a Roth IRA before you reach age 70 1/2.

Do you have a personal finance question for our experts? Write to AskTheExpert@moneymail.com.

Read next: The Pros and Cons of Hiring a Financial Adviser

MONEY 401(k)s

1 in 3 Older Workers Likely to Be Poor or Near Poor in Retirement

businessman reduced to begging
Eric Hood—iStock

Fewer Americans have access to a retirement plan at work. If you're one of them, here's what you can do.

A third of U.S. workers nearing retirement are destined to live in or near poverty after leaving their jobs, new research shows. One underlying cause: a sharp decline in employer-sponsored retirement plans over the past 15 years.

Just 53% of workers aged 25-64 had access to an employer-sponsored retirement savings plan in 2011, down from 61% in 1999, according to a report from Teresa Ghilarducci, professor of economics at the New School. More recent data was not available, but the downward trend has likely continued, the report finds.

This data includes both traditional pensions and 401(k)-like plans. So the falloff in access to a retirement plan is not simply the result of disappearing defined-benefit plans, though that trend remains firmly entrenched. Just 16% of workers with an employer-sponsored plan have a traditional pension as their primary retirement plan, vs. 63% with a 401(k) plan, Ghilarducci found.

Workers with access to an employer-sponsored plan are most likely to be prepared for retirement, other research shows. So the falling rate of those with access is a big deal. In 2011, 68% of the working-age U.S. population did not participate in an employer-sponsored retirement plan. The reasons ranged from not being eligible to not having a job to choosing to opt out, according to Ghilarducci’s research.

She reports that the median household net worth of couples aged 55-64 is just $325,300 and that 55% of these households will have to subsist almost entirely on Social Security benefits in retirement. The Center for Retirement Research at Boston College and the National Institute on Retirement Security, among others, have also found persistent gaps in retirement readiness. Now we see where insufficient savings and the erosion of employer-based plans is leading—poverty-level retirements for a good chunk of the population.

At the policy level, we need to encourage more employers to offer a retirement plan. On an individual level, you can fix the problem with some discipline. Even those aged 50 and older have time to change the equation by spending less, taking advantage of tax-deferred catch-up savings limits in an IRA or 401(k), and planning to stay on the job a few years longer. That may sound like tough medicine, but it’s nothing next to struggling financially throughout your retirement.

MONEY 401k plans

What You Can Learn From 401(k) Millionaires in the Making

These folks are doing all the right things to reach retirement with a seven-figure nest egg.

The 401(k) has become the No. 1 way for Americans to save for retirement. And save they have. The average plan balance has hit a record high, and the number of million-dollar-plus 401(k)s has more than doubled since 2012. In the first part of this series, we shared tips for building a $1 million retirement plan. Now meet workers on track to join the millionaires club—and get inspired by their smart moves. Once you hit your goal, learn more about making your money last and getting smart about taxes when you draw down that $1 million.
  • Greg and Jesseca Lyons, both 30

    Greg and Jesseca Lyons

    Carmel, Indiana
    Years to $1 million: 15
    Best move: Never cashed out their 401(k)s

    Though only 30, Greg and Jesseca Lyons are well on their way to reaching their retirement goals. The Lyons—he’s an operations manager for a small research company, she’s a product development engineer for a medical device maker—are on the same page when it comes to planning for the future.

    College sweethearts who have been married seven years, they made a commitment to start investing for retirement with their first jobs. They contribute 15% of their salaries. Employer matches bring that annual savings rate to about 19%. Together, they have $250,000 in their retirement accounts, invested 90% in stocks and 10% in bonds.

    Unlike many young people, they have resisted the temptation to cash out their 401(k)s when they changed jobs. Though they dialed back contributions for about six months when they were saving for a down payment, the Lyons didn’t stop putting money away. “We have stuck with the idea that retirement money is retirement money forever,” says Greg. His goal is to retire by age 60. For Jesseca, saving is about independence and financial security. “I love what I do, so I don’t see retiring early. But I don’t want to be worried or stressed out about our money either,” she says. “I am not going to sacrifice our retirement just to live a certain lifestyle now.”

  • Tajuana Hill, 46

    By starting to save for retirement at age 26, Tajuana Hill has put herselv on track to grow a seven-figure 401(k).
    Jesse Burke

    Indianapolis
    Years to $1 million: 17
    Best Move: Keeps raising her savings rate

    It’s taken Tajuana Hill, an employee trainer with Rolls-Royce, two decades to max out her 401(k), but she’s been a steady saver since her twenties. When she joined the firm at age 26, she put 10% of her pay into her plan right away. As her income rose, she ramped that up to 12%, then 17%, and finally 20% in January.

    Her reward: $224,000 in her 401(k)—all the more impressive since her employer offers no match. What has helped Hill is a side business she launched three years ago, Mimosa and a Masterpiece, an art studio where students can sip a drink during painting classes taught by local artists. The extra income let her pay off her credit cards, freeing up earnings from her day job so she could boost her 401(k) contributions.

    “When I retire, I hope to do it as a millionaire,” says Hill. If she sticks to this regimen, her 401(k) could top $1 million just as she reaches 65.

  • Steven and Melanie Thorne, both 37

    Steve and Melanie Thorne have been disciplined about hiking their retirement contributions with every raise. Melanie saves 10% of her pay in her plan, while Steve sets aside 12%. They even save extra in Roth IRAs.
    Jesse Burke

    York, Pennsylvania
    Years to $1 million: 15
    Best move: Invest in low-cost stock index funds

    Having a healthy stake in stocks is a hallmark of 401(k) millionaires. With decades to go until retirement, you can ride out market swings. That’s a philosophy Steven and Melanie Thorne have embraced. Together they have $310,000 in their workplace retirement plans, Roth IRAs, and a brokerage account, all invested 100% in stocks. “We are young, so we can be more aggressive,” says Steve, a security officer at a nuclear power plant.

    Investing is a passion for Steven, who first started saving for retirement with a Roth IRA when he was 18. He says he follows Warren Buffett’s philosophy about buying stocks: Be greedy when others are fearful, be fearful when others are greedy. But, he says, he and Melanie, a nurse, are buy-and-hold investors and keep most of their portfolio in low-cost index funds.

    Steven and Melanie have been disciplined about hiking their retirement contributions with every raise. Melanie saves 10% of her pay in her plan, while Steven sets aside 12%. They even save extra in Roth IRAs. They live below their means and direct tax refunds into retirement accounts, as well as save for college for their five year old son Chase. “We look for extra ways to save cash and keep our investment costs low,” says Steven.

  • Jonathan and Margaret Kallay, 56 and 53

    By saving more as big expenses fell away and their incomes rose, Jonathan and Margaret Kallay have been able to amass 401(k)s worth a combined $750,000.
    Jesse Burke

    Westerville, Ohio
    Years to $1 million: Four
    Best move: Power saving late

    Life can get in the way of saving for retirement, but ramping up your savings later in your career pays off. Jonathan and Margaret Kallay contributed only small amounts to their retirement plans early on. “It wasn’t much, about $50 a paycheck on a $13,000-a-year salary,” says Jonathan, a firefighter. Margaret, then an ER nurse, put away 5% of her pay.

    As big expenses fell away, the Kallays saved more. Married in 1993, the couple each paid child support for daughters from previous marriages until the girls reached 18. Once that ended and they paid off car loans, the money went toward retirement.

    Earning more has helped too. Jonathan worked extra shifts as a paramedic. Margaret got a business degree and is now a vice president at an insurance company, where she gets a generous company match. They each put about 15% in their 401(k)s, which total $750,000 and could hit $1 million in four years. They plan to quit work soon to spend more time traveling and spending time with their daughters and 5-year-old twin grandsons. “We’ve made a lot of sacrifices to invest for retirement,” says Jonathan. “It’s all been worth it.”

  • Mel and Heather Petersen, both 35

    Mel and Heather Petersen with sons Carter and Perry

    Reidsville, N.C.
    Years to $1 million: 17
    Best move: Buying rental properties to bring in more money

    Despite modest incomes in the early years of their careers, Mel and Heather Petersen have accumulated nearly $200,000 in retirement savings. Their strategy: Consistent saving. Mel, a public school teacher, says his salary has averaged about $40,000 most of his working life. Today he earns $50,000 a year. Heather, a marketing analyst who contributes 10% of her income to her 401(k), has seen a steadier increase in her earnings over the years, bringing the couple to a six-figure combined income.

    “We have always saved money for retirement no matter what our income, and never stopped no matter what financial challenges we have faced,” says Mel, dad to two boys, 8-year-old Carter and 4-year-old Perry.

    It helps that the Petersens supplement their retirement savings with income from rental properties that they began buying seven years ago. Several are paid off, and after expenses they gross about $5,000 a month in rental income. They hope to continue investing in real estate to boost their retirement savings. “We want to max out our retirement accounts down the road,” says Mel.

  • Larry and Christianne Schertel, both 58

    Larry and Christie Schertel

    Valatie, New York
    Years to $1 million: zero
    Best move: Kept faith in stocks

    Investors have enjoyed a roaring bull market for the past six years. But financial markets are cyclical. Even the most dedicated savers can panic and abandon stocks when the markets goes south.

    Despite the massive downturn during the Great Recession, Larry and Christianne Schertel didn’t budge from their 75% stock allocation. “When the market collapsed in 2008, we stayed the course and were nicely rewarded as the markets rebounded,” says Larry, an operations manager at a transportation company until his retirement this January. As they closed in on retirement, the Schertels reduced equities to about 60%. Together with Christianne, who works as an elementary school teaching assistant, the Schertels have just over $1 million in retirement accounts.

    In addition to their resolve during market fluctuations, the Schertels say automating their savings, living below their means, limiting debt, and investing in low-cost funds helped them reach the $1 million mark. “There really is no magic to it,” says Larry. “It is just being disciplined.”

MONEY Savings

Why Many Middle-Class Households Are Outsaving the Wealthy

big piggy bank and gold piggy bank
Kyu Oh/Getty Images (left)—Alamy (right)

It might seem counterintuitive, but the best savers can be found in the middle class.

Can it be that Americans are finally getting the message about saving for retirement?

Granted, studies have repeatedly confirmed America’s lack of savings. And the overall results of a new Bankrate.com survey seem to add to the pile: One in five Americans is saving nothing at all, while 28% are saving just 5% of their income or less. Overall, a mere 24% are saving more than 10% of their incomes, and only 14% of Americans are stashing away more than 15%.

But the survey also highlights an emerging countertrend: Many Americans are saving a lot—and, shocker, they’re folks in the middle class. Some 35% of households earning between $50,000 and $74,999 are putting away more than 10% of their incomes, including 14% who are saving more than 15%, according to Bankrate.com’s Financial Security Index. By contrast, only 19% of higher-income households (those earning $75,000 or more) are saving at that rate.

Why are middle-class savers outpacing their wealthier peers? “The middle class are increasingly aware that the saving for retirement is on them, and many have the discipline to do what’s necessary,” says Greg McBride, Bankrate.com’s chief financial analyst. “And they know they won’t have the resources of wealthier households if they fall short.”

The strengthening economy and improved job outlook have also provided a boost, since more households have additional money to put away. Americans also are also increasingly optimistic about their future income. Overall some 27% of workers are feeling more secure in their jobs than they did a year ago, which is twice the percentage of those who feel less secure (13%). And nearly 30% of those surveyed say their financial situation has improved vs. 18% who say it has deteriorated.

Still, most Americans remain financially challenged, as Bankrate’s study shows:

  • While 23% of those surveyed feel more comfortable with their debt level compared with a year ago, some 20% are feeling less comfortable, while the rest feel about the same.
  • Some 24% of respondents feel better about their savings vs the previous year, but 27% are less comfortable—though, as Bankrate pointed out, that margin was the smallest to date.
  • When asked about their net worth, only 24% reported it to be higher compared with last year, while most said it was lower (14%) or about same (57%).

The Bankrate.com survey did not ask whether workers were participating in a 401(k), but other research shows that consistent saving in a plan throughout your career is key to reaching your financial goals. As a recent study by Empower Retirement found, those with access to a 401(k) or other retirement plan had lifetime income scores (a measure of retirement readiness) of 74%, while those who lacked plans had an average score of just 42%. Unfortunately, only about half of workers have access to an employer plan.

Even if you do have a 401(k), it’s difficult to save consistently, and avoid tapping that money, over the course of three decades. Stuff happens, including job changes, layoffs, and health emergencies. Still, those who at least try to save end up much better off than those who don’t, as a 2014 study shows. And for the lucky few who stick to their plan—who knows?—you may even end up a 401(k) millionaire.

Read next: Here’s How to Tell If You’re Saving Enough for Retirement

MONEY Taxes

For Some Retirees, April 1 is a Crucial Tax Deadline

If you recently reached your 70s and aren't yet drawing money from your tax-deferred retirement accounts, you need to act fast.

For anyone who turned 70½ last year and has an individual retirement account, April 15 isn’t the only tax deadline you need to pay attention to this time of year.

With a traditional IRA, you must begin taking money out of your account after age 70½—what’s known as a required minimum distribution (RMD). And you must take your first RMD by April 1 of the year after you turn 70½. After that, the annual RMD deadline is December 31. After years of tax-deferred growth, you’ll face income taxes on your IRA withdrawals.

Figuring out your RMD, which is based on your account balance and life expectancy, can be tricky. Your brokerage or fund company can help, or you can use these IRS worksheets to calculate your minimum withdrawal.

Failure to pull out any or enough money triggers a hefty penalty equal to 50% of the amount you should have withdrawn. Despite the penalty, a fair number of people miss the RMD deadline.

A 2010 report by the Treasury Inspector General estimated that every year as many as 250,000 IRA owners miss the deadline for their first or annual RMD, failing to take distributions totaling some $350 million. That generates potential tax penalties of $175 million.

The rules are a bit different with a 401(k). If you’re still working for the company that sponsors your plan, you can waive this distribution rule until you quit. Otherwise, RMDs apply.

“It’s becoming increasingly common for folks to stay in the workforce after traditional retirement age,” says Andrew Meadows of Ubiquity Retirement + Savings, a web-based retirement plan provider specializing in small businesses. “If you’re still working you can leave the money in your 401(k) and let compound interest continue to do its work,” says Meadows.

What’s more, with a Roth IRA you’re exempt from RMD rules. Your money can grow tax-free indefinitely.

If you are in the fortunate position of not needing the income from your IRA, you can’t skip your RMD or avoid income taxes. You may want to reinvest the money, gift it, or donate the funds to charity, though a law that allowed you to donate money directly from an IRA expired last year and has not yet been renewed. Another option is to convert some of the money to a Roth IRA. You’ll owe income taxes on the conversion, but never face RMDs again.
Whatever you do, if you or someone you know is 70-plus, don’t miss the April 1 deadline. There’s no reason to give Uncle Sam more than you owe.

 

MONEY Taxes

How to Make Tapping a $1 Million Retirement Plan Less Taxing

adding machine printing $100 bill
Sarina Finkelstein (photo illustration)—Mike Lorrig/Corbis (1); iStock (1)

With a seven-figure account balance, you have to work extra hard to minimize the tax hit once you starting taking withdrawals.

More than three decades after the creation of the 401(k), this workplace plan has become the No. 1 way for Americans to save for retirement. And save they have. The average plan balance has hit a record high, and the number of million-dollar-plus 401(k)s has more than doubled since 2012.

In the first part of this four-part series, we laid out how to build a $1 million 401(k) plan. Part two covered making your money last. Next up: getting smart about taxes when you draw down that $1 million.

Most of your 401(k) money was probably saved pretax, and once you start making withdrawals, Uncle Sam will want his share. The conventional wisdom would have you postpone taking out 401(k) funds for as long as possible, giving your money more time to grow tax-deferred. But retirees must start making required minimum distributions (RMDs) by age 70½. With a million-dollar-plus account, that income could push you into a higher tax bracket. Here are three possible ways to reduce that tax bite.

1. Make the Most of Income Dips

Perhaps in the year after you retire, with no paycheck coming in, you drop to the 15% bracket (income up to $73,800 for a married couple filing jointly). Or you have medical expenses or charitable deductions that reduce your taxable income briefly before you bump back up to a higher bracket. Tapping pretax accounts in low-tax years may enable you to pay less in taxes on future withdrawals, says Marc Freedman, a financial adviser in Peabody, Mass.

2. Spread Out the Tax Bill

Taking advantage of low-tax-bracket years to convert IRA money to a Roth can cut your tax bill over time. Just make sure you have cash on hand to pay the conversion taxes.

Say you and your spouse are both 62, with Social Security and pension income that covers your living expenses, as well as $800,000 in a rollover IRA. If you leave the money there, it will grow to nearly $1.1 million by the time you start taking RMDs, assuming 5% annual returns, says Andrew Sloan, a financial adviser in Louisville.

If you convert $50,000 a year to a Roth for eight years instead, paying $7,500 in income taxes each time, you can stay in the 15% bracket. But you will end up paying less in taxes when RMDs begin, since your IRA balance will be only $675,000. Meanwhile, you will have $475,000 in the Roth. Another benefit: Since Roth IRAs aren’t subject to RMDs, you can pass on more of your IRAs to your heirs.

3. Plot Your Exit from Employer Stock

Some 401(k) investors, often those with large balances, hold company stock. Across all plans, 9% of 401(k) assets were in employer shares at the end of 2013, Vanguard data show—for 9% of participants, that stock accounts for more than 20% of their plan.

Unloading those shares at retirement will reduce the risk in your portfolio. Plus, that sale may cut your tax bill. That’s because of a tax rule called net unrealized appreciation (NUA), which is the difference between the price you paid for the stock and its market value.

Say you bought 5,000 shares of company stock in your 401(k) at $20 a share, for a total price of $100,000. Five years later the shares are worth $50, or $250,000 in total. That gives you a cost of $100,000, and an NUA of $150,000. At retirement, you could simply roll that stock into an IRA. But to save on taxes, your best move may be to stash it in a taxable account while investing the balance of your plan in an IRA, says Jeffrey Levine, a CPA at IRAhelp.com.

All rollover IRA withdrawals will be taxed at your income tax rate, which can be as high as 39.6%. When you take company stock out of your 401(k), though, you owe income tax only on the original purchase price. Then, when you sell, you’ll owe long-term capital gains taxes of no more than 20% on the NUA.

Of course, these complex strategies may call for an accountant or financial adviser. But after decades of careful saving, you don’t want to jeopardize your million-dollar 401(k) with a bad tax move.

MONEY 401(k)s

How to Build a $1 Million Retirement Plan

$100 bricks and mortar
Money (photo illustration)—Getty Images(2)

The number of savers with seven-figure workplace retirement plans has doubled over the past two years. Here's how you can become one of them.

The 401(k) was born in 1981 as an obscure IRS regulation that let workers set aside pretax money to supplement their pensions. More than three decades later, this workplace plan has become America’s No. 1 way to save. According to a 2013 Gallup survey, 65% of those earning $75,000 or more expect their 401(k)s, IRAs, and other savings to be a major source of income in retirement. Only 34% say the same for a pension.

Thirty-plus years is also roughly how long you’ll prep for retirement (assuming you don’t get serious until you’ve been on the job a few years). So we’re finally seeing how the first generation of savers with access to a 401(k) throughout their careers is making out. For an elite few, the answer is “very well.” The stock market’s recent winning streak has not only pushed the average 401(k) plan balance to a record high, but also boosted the ranks of a new breed of retirement investor: the 401(k) millionaire.

Seven-figure 401(k)s are still rare—less than 1% of today’s 52 million 401(k) savers have one, reports the Employee Benefit Research Institute (EBRI)—but growing fast. At Fidelity Investments, one of the largest 401(k) plan providers, the number of million-dollar-plus 401(k)s has more than doubled since 2012, topping 72,000 at the end of 2014. Schwab reports a similar trend. And those tallies don’t count the two-career couples whose combined 401(k)s are worth $1 million.

Workers with high salaries have a leg up, for sure. But not all members of the seven-figure club are in because they make big bucks. At Fidelity thousands earning less than $150,000 a year have passed the million-dollar mark. “You don’t have to make a million to save a million in your 401(k),” says Meghan Murphy, a director at Fidelity.

You do have to do all the little things right, from setting and sticking to a high savings rate to picking a suitable stock and bond allocation as you go along. To join this exclusive club, you need to study the masters: folks who have made it, as well as savers who are poised to do the same. What you’ll learn are these secrets for building a $1 million 401(k).

1) Play the Long Game

Fidelity’s crop of 401(k) millionaires have contributed an above-average 14% of their pay to a 401(k) over their careers, and they’ve been at it for a long time. Most are over 50, with the average age 60.

Those habits are crucial with a 401(k), and here’s why: Compounding—earning money on your reinvested earnings as well as on your original savings—is the “secret sauce” to make it to a million. “Compounding gives you a big boost toward the end that can carry you to the finish line,” says Catherine Golladay, head of Schwab’s 401(k) participant services. And with a 401(k), you pay no taxes on your investment income until you make withdrawals, putting even more money to work.

You can save $18,000 in a 401(k) in 2015; $24,000 if you’re 50 or older. While generous, those caps make playing catch-up tough to do in a plan alone. You need years of steady saving to build up the kind of balance that will get a big boost from compounding in the home stretch.

Here’s how to do it:

Make time your ally. Someone who earns $50,000 a year at age 30, gets 2% raises, and puts away 14% of pay on average will have $547,000 by age 55—a hefty sum that with continued contributions will double to $1.1 million by 65, assuming 6% annualized returns. Do the same starting at age 35, and you’ll reach $812,000 at 65.

Yet saving aggressively from the get-go is a tall order. You may need several years to get your savings rate up to the max. Stick with it. Increase your contribution rate with every raise. And picking up part-time or freelance work and earmarking the money for retirement can push you over the top.

Milk your employer. For Fidelity 401(k) millionaires, employer matches accounted for a third of total plan contributions. You should squirrel away as much of the boss’s cash as you can.

According to HR association WorldatWork, at a third of companies 50% of workers don’t contribute enough to the company 401(k) plans to get the full match. That’s a missed opportunity to collect free money. A full 80% of 401(k) plans offer a match, most commonly 50¢ for each $1 you contribute, up to 6% of your salary, but dollar-for-dollar matches are a close second.

Broaden your horizons. As the graphic below shows, power-saving in your forties or fifties may bump you up against your 401(k)’s annual limits. “If you get a late start, in order to hit the $1 million mark, you will need to contribute extra savings into a brokerage account,” says Dirk Quayle, president of NextCapital, which provides portfolio-management software to 401(k) plans.

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2) Act Like a Company Lifer

The Fidelity 401(k) millionaires have spent an average of 34 years with the same employer. That kind of staying power is nearly unheard-of these days. The average job tenure with the same employer is five years, according to the Bureau of Labor Statistics. Only half of workers over age 55 have logged 10 or more years with the same company. But even if you can’t spend your career at one place—and job switching is often the best way to boost your pay—you can mimic the ways steady employment builds up your retirement plan.

Here’s how to do it:

Consider your 401(k) untouchable. A fifth of 401(k) savers borrowed against their plan in 2013, according to EBRI. It’s tempting to tap your 401(k) for a big-ticket expense, such as buying a home. Trouble is, you may shortchange your future. According to a Fidelity survey, five years after taking a loan, 40% of 401(k) borrowers were saving less; 15% had stopped altogether. “There are no do-overs in retirement,” says Donna Nadler, a certified financial planner at Capital Management Group in New York.

Even worse is cashing out your 401(k) when you leave your job; that triggers income taxes as well as a 10% penalty if you’re under age 59½. A survey by benefits consultant Aon Hewitt found that 42% of workers who left their jobs in 2011 took their 401(k) in cash. Young workers were even more likely to do so. As you can see in the graphic below, siphoning off a chunk of your savings shaves off years of growth. “If you pocket the money, it means starting your retirement saving all over again,” says Nadler.

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Resist the urge to borrow and roll your old plan into your new 401(k) or an IRA when you switch jobs. Or let inertia work in your favor. As long as your 401(k) is worth $5,000 or more, you can leave it behind at your old plan.

Fill in the gaps. Another problem with switching jobs is that you may have to wait to get into the 401(k). Waiting periods have shrunk: Today two-thirds of plans allow you to enroll in a 401(k) on day one, up from 57% five years ago, according to the Plan Sponsor Council of America. Still, the rest make you cool your heels for three months to a year. Meanwhile, 40% of plans require you to be on the job six months or more before you get matching contributions.

When you face a gap, keep saving, either in a taxable account or in a traditional or Roth IRA (if you qualify). Also, keep in mind that more than 60% of plans don’t allow you to keep the company match until you’ve been on the job for a specific number of years, typically three to five. If you’re close to vesting, sticking around can add thousands to your retirement savings.

Put a price on your benefits. A generous 401(k) match and friendly vesting can be a lucrative part of your compensation. The match added about $4,600 a year to Fidelity’s 401(k) millionaire accounts. All else being equal, seek out a generous retirement plan when you’re looking for a new job. In the absence of one, negotiate higher pay to make up for the missing match. If you face a long waiting period, ask for a signing bonus.

3) Keep Faith in Stocks

Research into millionaires by the Spectrem Group finds a greater willingness to take reasonable risks in stocks. True to form, Fidelity’s supersavers have 75% of their assets in stocks on average, vs. 66% for the typical 401(k) saver. That hefty equity stake has helped 401(k) millionaires hit seven figures, especially during the bull market that began in 2009.

What’s right for you will depend in part on your risk tolerance and what else you own outside your 401(k) plan. What’s more, you may not get the recent bull market turbo-boost that today’s 401(k) millionaires enjoyed. With rising interest rates expected to weigh on financial markets, analysts are projecting single-digit stock gains over the next decade. Still, those returns should beat what you’ll get from bonds and cash. And that commitment to stocks is crucial for making it to the million-dollar mark.

MONEY retirement planning

The Growing Divide Between the Retirement Elite and Everyone Else

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Americans are on track to replace 60% of income, but only one in five pre-retirees report good health. That's likely to prove costly.

There’s a growing retirement savings gap between workers with 401(k)s and those without.

Overall the typical American worker is on track to replace about 58% of current pay through savings at retirement. That’s according to a new Lifetime Income Score study, by Empower Retirement, which calculated the income workers are on track to receive from retirement plans and other financial assets, as well as Social Security benefits.

“Those who have workplace plans like 401(k)s aren’t doing too badly, but there’s a big savings deficit for those who don’t have them,” says Empower president Ed Murphy. (Formed through a recent merger, Empower combines the retirement services of Putnam, Great-West and J.P. Morgan.)

Those with access to a 401(k) or other retirement plan had lifetime income scores of 74%, while those lacked plans had an average score of just 42%. It’s one reason this year’s overall score of 58% is a slight dip from last year’s score of 61% .

Living well on just 58% of current income is certainly possible—many retirees are doing just fine at that level. But financial planners typical suggest aiming for a 75% to 80% replacement rate to leave room for unexpected costs. And for many workers, it’s possible to close the savings gap by stepping up 401(k) contributions by staying on the job longer.

But truth is, most workers end up retiring well before age 65, and few have enough saved by that point. The least prepared workers, some 32% of those surveyed, were on track to receive just 38% of their income in retirement, which would be largely Social Security benefits.

By contrast, an elite group of workers, some 20%, are on track to replace 143% of their current income, Empower found. And it’s not just those pulling down high salaries. “The key success factors were access to a 401(k) and consistently saving 10% of pay, not income,” Murphy says.

Access to a financial adviser also made a big difference in whether workers were on track to a comfortable retirement income. Those who worked with a pro were on track to replace 82% of income vs 55% for those without. And for those with a formal retirement plan, their lifetime income score hit 87% vs the average 58%.

For all retirement savers, however, health care costs are a looming problem. Only 21% of those ages 60 to 65 reported having none of six major medical issues, such as diabetes or tobacco use. For the typical 65-year-old couple, health care expenses, including Medicare premiums and out-of-pocket costs, might reach $220,000 over the course of retirement, according to a Fidelity analysis. Those in worse health can expect to pay far higher costs, which means you should plan to save even more.

Here are other key findings from the Empower study:

  • Nearly two-thirds of workers lack confidence about their ability to cover health care costs in retirement
  • Some 75% say they have little or no concern about job security, vs. 60% in 2012.
  • Some 72% of workers are somewhat interested or very interested in guaranteed income options, such as annuities.
  • The percentage of workers considering delaying retirement is falling—some 30% now vs. 41% from a peak in 2012.
  • Many are hoarding cash, which accounts for 35% of retirement plan assets. For those without advisers, that allocation is a steep 55%.

Clearly, estimating your retirement income is crucial to achieving your financial goals—and studies have shown that going through that exercise can help spur saving. More 401(k) plans are offering tools and other guidance to help savers estimate their retirement income and help you choose the right stock and bond allocation. For those who aren’t participating in a 401(k) plan, try the T. Rowe Price retirement income calculator, which is free.

MONEY 401(k)s

Here’s How to Tell If You’re Saving Enough for Retirement

This month's MONEY poll looks at our habits when it comes to retirement savings. Click through the gallery to see how you compare with your fellow readers.

  • Men Have Bigger Balances

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    But women are 10% more likely to enroll in a workplace plan, and they save at higher rates (up to 12%) than their male colleagues.

  • Most of Us Will Save More This Year

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    In a poll of more than 500 MONEY readers, the majority said they’d put away more for retirement this year than last year.

  • How Much We’re Socking Away

    Average 401(k) contribution in 2014
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    The average 401(k) contribution last year was up 15% from 2009.

  • What We’ll Be Living On in Retirement

    For most people, Social Security will account for a substantial portion of income in retirement.

  • Trending in the Right Direction

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    401(k) balances topped out at a record $91,300 at the end of 2014, according to Fidelity.

  • But Still Not Good Enough

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    The Natixis Global Retirement Report ranks the U.S. 19th, behind Australia (3), Germany (9), and Japan (13), but ahead of the United Kingdom (22).

  • The States That Save the Most

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    San Jose—home to many well-paid high-tech workers—leads the nation in 401(k) participation. Bringing up the rear: El Paso, Texas, where workers save just 5.7% of salary.

  • Are You Saving Enough?

    150318_RET_NestEgg_Slideshow_8
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    The average employee is saving just over 8%, the highest rate in the past four years.

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