No matter if you’re just starting out saving for retirement or have been doing it for years, one of the most common questions people will ask is “How much should I put in my 401k?”
It’s a very good question to ask! Save too little and you might end up having to work until you’re 80 years old. But then again if you save too much, you might be cutting yourself short in the present. So then how can we land somewhere in the middle? Is there some kind of optimal percentage you are supposed to contribute to your 401k plan that would take care of all your worries?
Fortunately the topic of how much to save for retirement is something that has been studied by many intelligent people, and a great deal of theories exist on the subject.
Below is a choice selection of some of the best 401k savings strategies around:
1. Save Enough to Get Your Full Employer Match:
As you may already know, when you participate by saving for retirement with a 401k plan, most employers will reward you by kicking in some extra money (called matching contributions) to help you along. That’s free and easy money!
The rules for getting your employer’s matching contributions are different for every employer. I’ve heard of everything from people who match dollar-for-dollar, fifty cents to a dollar, and a quarter to a dollar every time you save.
Sometimes certain employers will have different tiers for their matching contributions. I once heard about an employer that gives you 4% to start off with (no matter how much you contribute), and an additional 4% after you contribute 4% or higher.
Lesson Learned: Employer matching contributions are free money! If you’re trying to determine what percentage to contribute to your 401k plan, make sure it’s at least enough to guarantee you’re getting the FULL match and getting everything you’re entitled to.
If your 401k plan does not offer a very good matching incentive, then you may want to consider one of the other following strategies or combining your savings efforts with an IRA.
2. Contribute Up the 401k Max to Save on Taxes:
Another popular theory on how much to save in your 401k is to do this one simple thing – save all the way up to the maximum limit! (By the way, that’s $18,000 for 2015).
Why would anyone suggest that? For one single reason – “taxes”. Every dollar you contribute to your 401k (or even your IRA) is tax-deferred. When you compare this to the amount of money you would have had if you had just cashed in your paycheck, it’s quite a bit more!
How much more? The math is pretty simple. Let’s assume you’re in the 25% tax bracket. That means for every dollar you make, by the time you cash your paycheck you really only get to keep 75 cents.
BUT with a 401k, you keep that whole $1 because it didn’t get taxed. Therefore you’re saving:
($1 / $0.75) = (4/3) = +33%
Wow, you get to save 33% more because you used your 401k to save for retirement instead of saving with your taxable income.
And that’s where saving all the way up to the maximum contribution limit comes in. By saving all the way up to that $18,000 mark, you’re keeping $4,500 of your money for yourself instead of giving it away to Uncle Sam!
Lesson Learned: The more you save in your 401k account, the more you keep for yourself and the less you give away to taxes. Figure out what percentage of your income it will take to save $18,000 in your 401k every year and make an effort to achieve it.
3. Put In 17% of Your Income:
One of the great minds in the field of retirement savings strategies, Dr Wade Pfau, once published an interesting paper on safe savings rates that gained the attention of Money Magazine.
In the article it was summarized that Dr Pfau suggested that an approximate savings rate of 17% would give you the best odds of achieving a sustainable retirement nest egg.
This, of course, was based on a number of variables. For example the study assumed you worked for a minimum of 30 years. It also assumed employer contributions were part of this 17% figure.
Lesson Learned: While you may or may not fit the profile of the person this study was modeled after, this 17% savings figure does give you some rough idea of what an ideal 401k contribution percentage would be.
Only You Know How Much Should Put in Your 401k:
Even though all of these are good suggestions to take into consideration, the real answer ultimately lies with you.
What I mean by this is that only you know:
- How long you want to work
- What your investment style is like, and
- How lavishly you want to live when you finally do retire.
- If you plan to live in a huge mansion and travel to tropical locations every month when you retire, then you’re going to need to make sure you have a very high contribution percentage.
- Perhaps you want to retire by age 55. For people who want to finish work more quickly they are going to need to save more aggressively than everyone else.
- If you plan to live somewhat modest (or similar to how you are now) when you retire, then maybe you don’t need such a high savings rate.
- Maybe you plan to work for a number of years and live off a modest income, but you’re scared to invest in stocks. Then that means you’d have to save a high contribution percentage in order to make up for investing conservatively.
If you really want to figure out how much you should put in your 401k, make some guesses about what your retirement budget will be and use a good online calculator to see what your annual savings habits should be. Be sure to estimate on the high side! Once you come up with a reasonable figure, decide how you can shape your present financial situation to help achieve your retirement goal.
Along the way use a free financial tracker like the one offered by Personal Capital to make sure your investments are growing at the rate you’d like to see. I like using this program to keep track of all my finances because it gives me a complete snapshot of my finances at all times. For anyone who’s ever had to login to multiple accounts and manually track things on their own, they know what a big time-saver a service like this can be. And plus since its completely FREE that makes it even better.
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