How Much Should You Contribute To Your 401 Rule Of Thumb
As a rule of thumb, experts advise that you to save between 10% and 20% of your gross salary toward retirement. That could be in a 401 or in another kind of retirement account. No matter where you save it, you want to save as much for retirement as you can while still living comfortably.
Its important to say that this is just a general rule. The actual amount you should save depends on your individual situation. For example, if you are 50 years old and dont have any retirement savings, you should save more than 20% of your gross annual salary. If youre 30 years old and already have $100,000 in retirement savings, you could probably decrease your contributions for a bit in order to pay off a mortgage or loan. Its difficult to create a one-size-fits-all plan, because everyone is in a different place with his or her finances.
Saving 10% to 20% of your salary every year might sound like a lot. Luckily, you dont have to do it all at once. You can spread your contributions out throughout the year and you can contribute more or less some years. You also dont have to save all that money through your 401. Lets take a step back and talk about other factors you should consider when you think about how much to contribute to your 401.
Choosing Between Plans: The Traditional 401 Vs Roth 401
The money you contribute to a traditional 401 is tax-deferred. That means the amount comes out of your annual income before payroll taxes are taken from it. You pay the taxes on your contribution and whatever gains you made on the investment when you withdraw the money from the plan, so if you had very high investment gains, those will be subject to taxes at distribution.
If you withdraw the money before age 59½ or age 55, depending on your circumstances, you will not only be hit with the tax bill but an additional 10% early withdrawal penalty.
There are also rules about what your employer can do with your money Once your company sends the money to the investment firm after the plan administrator processes your contributions and executes the trades, your employer is out of the equation. Just know that, as with any investment, you can lose money in your 401 if the markets tank.
In both traditional and Roth 401 plans, once you sign up, your employer offers several different investments, usually through an asset manager like Fidelity or Vanguard. Those investments have varying levels of risk, so you must choose which one is most appropriate for your age and goals. You may also have the option of investing your contribution however you choose through a brokerage window in your account that allows you to buy stocks or ETFs if you’re not thrilled with the selection of funds your plan offers.
Get Help With Your 401
Already have a 401? While youre researching contributions, take a minute to analyze your current holdings toothere could be big savings to be found.
is a free app that creates easy-to-understand visuals of the investments you own in your 401, IRA, and other investment accounts. It then provides recommendations for how to rebalance your portfolio for maximum results and reduced expensesit can even show you how changing funds within your existing 401 might save you thousands. or read our review.
Blooom is a new tool that can automatically manage and optimize your 401 for just $10 a month. Designed especially for 401 accounts, blooom works with your available investments to find the lowest-cost and best allocation for your goals. You can get a free 401 analysis from Blooom or learn more in our review. Plus they have a special promotion where you can get $15 off your first year of Blooom with code BLMSMART
is a great all-in-one financial app that allows account holders to take control over their finances, automate saving and investing, and manage their accounts all in one place. Wealthfronts Self-Driving Money tool continuously monitors your cash flows to ensure that bills are paid and savings are instantly routed into the right investment accounts. Wealthfront account holders can also take advantage of the apps automated investment services, like daily rebalancing and tax-loss harvesting.
Read Also: What Is The Minimum 401k Distribution
It Never Hurts To Save More
Twenty percent is a great goal, but some retirement experts actually suggest saving more like 25% or even 30. Why?
You know that saying, Past returns are no guarantee of future performance? Thats why. Its true that the annual average return of the S& P 500 between 1928 and 2014 was 10%. But that doesnt mean well get that average return over the next 86 years.
Jack Bogle, the father of index funds and founder of Vanguard, says that investors should plan on lower returns in the coming decade and other commenters suggest lower yields even beyond that.
We have no way of knowing what future returns will bethey could be 8%, they could be 4%. But the only way to hedge against an uncertain future is to save more money. The more you have, the less you need jaw-dropping returns to meet your goals.
The Four Levels Of Retirement Savings
The lesson is: Figure out what percentage of your income you can save in total, and allocate it appropriately:
Level 1: Max out your employer match in your 401.
Level 2: Max out your emergency savings .
Level 3: Max out your Roth IRA .
Level 4: Max out your 401 .
This flowchart from my post on creating an automated investing program will also help:
Don’t Miss: How To Withdraw Money From My Fidelity 401k
Tips For Contributing To Your 401
- If youre struggling to get started or stay on track, consider working with a financial advisor. Our financial advisor matching tool can help you find a professional to work with. First, you answer some simple questions. Then, the tool links you up to three local advisors. You can then view their profiles and set up interviews before deciding to work with one.
- If you switch jobs, you can no longer contribute to a previous employers 401 plan. You dont want to lose the hard work you did to save that money, so you should look to make a direct 401 rollover to your new employers plan.
- A traditional IRA and a 401 offer similar tax benefits. You might wonder whether one is a better option for you. Heres an article to help you think about an IRA vs. a 401.
- You should always avoid early withdrawals from your 401. Not only will you have to pay the income tax, youll have to a pay 10% penalty. There are a couple of ways you could avoid that big penalty though. If you really think you need to withdraw money early, heres more information on 401 withdrawals.
What Are The Tax Implications Of 401 Contributions
Once you figure out how much to put into your 401, take a look at the different contribution types. Each has a unique tax treatment.
Pre-tax 401 contributions are not included in your taxable income for the year. They can lower your tax liability for the tax year in which you make the contribution. But you will pay income taxes on withdrawals from a traditional 401 plan.
This type is best if you are in a higher tax bracket in the years you are making contributions and expect to be in a lower tax bracket when you withdraw money from the 401 plan. What if you already have a lot of money in tax-deferred accounts? In that case, you might want to do more long-term planning before deciding if you should contribute even more pre-tax money to the plan.
Read Also: Can I Manage My Own 401k
Think About How Much You’ll Need In Retirement
Contributing the maximum to your 401 requires a lot of money especially as an ongoing, year-after-year commitment. It may or may not be enough to fund your retirement, or it could be even more than you need. Your 401 contribution amount should be guided by your retirement savings goal.
How much money you’ll need in retirement depends on when you plan to retire, how much of your current income youd like to replace and how much you want to rely on Social Security.
Most experts recommend saving 10% to 15% of your income, but our suggestion is to get a more detailed goal from a retirement calculator.
If you need to start at a lower contribution and work your way up, that’s fine. Aim to contribute at least enough to grab the match, then bump up the percent you contribute by 1% or 2% each year.
Which Is Right For You
First, check whether your employer offers a Roth 401 this account only took effect in 2006 and isnt offered by all firms. Approximately half of all plan sponsors now offer a Roth option. If you have a Roth 401 available, assess whether the Roth account provides similar features as the traditional 401, such as automatic enrollment.
Also, understand how your company’s matching contributions work . Many employers give you an incentive to participate in a 401 plan by matching your contributions consider contributing at least as much as needed to maximize your 401 match. If you have a company-provided match, your employer is allowed to make matching contributions even if you elect to participate in a Roth 401.
However, the company match must be made to the designated Roth 401 plan.
Some employers offer an after-tax 401 contribution option, but this can differ significantly from a Roth 401 and shouldnt be confused with a Roth 401.
Don’t Miss: What Is The Difference Between A Pension And A 401k
How Much You’ve Already Saved For Retirement
The higher your 401 balance, the less you’ll generally need contribute to your 401 plan as you approach retirement. The lower your balance, the more you’ll need to play catch up by contributing a higher percentage toward your retirement. To help determine how much your 401 could be worth over time, you can use a 401 growth calculator.
How Much Should I Save For Retirement
We get that question a lot. So we asked Stanley Poorman, advice and planning manager for Principal®, who said theres no one-size-fits-all answer.
A good rule of thumb is to save 1015% of your income toward retirement, but that also depends on when you get started. That may be fine if youre 25, but if youre starting at 50, you may need to save more to retire comfortably, Poorman says.
One way to get a quick snapshot of how much you may need to save is to use the Retirement Wellness Planner. By entering a few numbers, youll get a sense of whether youre on track or not.
Another factor is whether you have a matching contribution from your employer, and if so, what percentage the company contributes. Poorman suggests deferring enough of your pay to get that match.
Also Check: Should I Roll 401k To Ira
How To Set Savings Goals
Setting an achievable goal is an important step in retirement investing. One guidepost you can use is Fidelity’s recommendation to have one year’s salary saved by age 30, 4x your annual income saved by the time you reach age 45 and 10x your income by the time you reach 67. If you haven’t been able to save that much, you can make “catch-up” contributions after age 50 – adding an additional $6,000 above the 2019 contribution limit of $19,000 for a total of $25,000 a year.
To determine how much income you’ll need after you retire, consider that, although you may downsize your home or potentially relocate to a more affordable part of the country or even out of the country, there will be unknown factors that are difficult to prepare for.
Looking at your family’s average longevity compared with statistics showing people are generally living longer can help you estimate the amount you need to save. Figure that you could need anywhere between 45% to 80% of your current income, multiplied by about 30 years, in order to retire comfortably. Use that to set a goal.
That’s $1.68 million you will need if you want to retire on about 70% of your income per year until you’re 97.
Including gains and employer matches, that means that, on average, your 401 plan would need to increasing by $42,500 annually for about 40 years.
How Much Should I Put Into My 401 Out Of Each Paycheck
Aiming to put at least 15% of each paycheck into your 401 as long as you can still comfortably afford your living expenses is an excellent start on your way to saving for retirement. It’s suggested that if you can’t meet this amount, aim for the minimum amount to where your employer will match your 401 investment.
Read Also: Which 401k Investment Option Is Best
Dont Cash Out Your 401 Early
Another lesson: Whatever you do, dont cash out your 401 savings. If you leave your job, you are allowed to spend your 401 funds if you pay taxes on the amount, including a 10% penalty tax assessed on most withdrawals made before age 59 ½. You may be tempted to take the cash and spend it on a vacation before you start your next job, but thats not a very good idea.
Roll over that retirement money, sign up for the retirement plan with your new employer and take a nice and affordable staycation instead. Your retired self will be very grateful to your working self for making a small sacrifice that could have a big impact down the line.
Maximizing Your 401 And Ira Retirement Contributions
When you contribute to a 401, 403, or IRA, youre already on a path to help secure your financial future. But could you save more? Making the most of your organizations retirement plan now could help ensure your golden years are even more golden.
Read 5 steps to creating your retirement plan to help you get started.
You May Like: How To Diversify 401k Portfolio
Start Living On A Budget And Tracking Your Expenses
The fact is that until you know where your money is going each month youre going to have a hard time finding money to set aside for retirement savings.
The reason its so important to discover and track where your money is going each month is so that you can identify wasteful spending and reroute it toward causes that are more important to you.
Many people find when they start tracking expenses that they are spending money in $5, $10 and $20 increments that seems like its not a lot but adds up to hundreds or thousands of dollars each month.
When my family started tracking expenses in 2013, we were able to cut them down by nearly $1,000 a month and we were making well under $100,000 per year at the time.
By trimming grocery expenses, cutting back on entertainment costs and being more mindful of each purchase, we found a lot of waste in our spending. We were able to use what we were wasting for much more important things, such as paying off our debt.
How To Invest When To Withdraw
Pfau’s research highlights two other important variables. First, he notes that over time the safe withdrawal ratethe amount you can withdraw after retirement to sustain your nest egg for 30 yearswas as low as 4.1% in some years and as high as 10% in others. He believes that “we shift the focus away from the safe withdrawal rate and instead toward the savings rate that will safely provide for the desired retirement expenditures.”
Second, he assumes an investment allocation of 60% large-cap stocks and 40% short-term fixed-income investments. Unlike some studies, this allocation doesnt change throughout the 60-year cycle of the retirement fund . Changes in the persons portfolio allocation could have a significant impact on these numbers, as can fees for managing that portfolio. Pfau notes that “simply introducing a fee of 1% of assets deducted at the end of each year would increase the baseline scenarios safe savings rate rather dramatically from 16.62% to 22.15%.”
This study not only highlights the pre-retirement savings needed but emphasizes that retirees have to continue managing their money to prevent spending too much too early in retirement.
Recommended Reading: Can You Use Your 401k To Buy Real Estate
Why Should I Use One
Matching dollars, for one thing. Over 90% of employers that offer a 401 plan also kick in a matching contribution, which means as you contribute, your employer will, too. Commonly, that match will be worth 50% to 100% of your contributions, up to a limit that typically falls between 3% and 6% of your annual income. If your employer offers up this free money, a good rule of thumb is to do everything you can to contribute enough to take advantage of it.
The other huge benefit of the 401 is that it allows you to put a lot of money away for retirement in a tax-advantaged way. The annual contribution limit is $19,500 for tax year 2021, with an extra $6,500 allowed as a catch-up contribution every year for participants age 50 or older.
Consider The Ira And Roth Ira Option
If your company does not offer an employerâs match, or if you have additional cash to save, you should rollover to an IRA, either a traditional IRA or Roth IRA. An IRA offers greater control to retirement savers, and you have access to a wide pool of investment options. However, an IRA has a lower contribution limit of $6,000 a year, and a catch-up contribution of $1000 for those age 50 or older.
A traditional IRA is a tax-advantaged retirement account, and you will not pay taxes on the contributions you make. The money grows tax-free, but you will owe taxes when you withdraw funds. With a Roth IRA, you pay tax on the contributions you make to the retirement plan. You donât pay taxes on the investment returns and distributions. Therefore, Roth IRA money is more valuable in retirement since you wonât be required to pay taxes in retirement.
Read Also: How Do I Find Out Where My Old 401k Is