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How Much Can You Contribute To A 401k Per Year – Most of you reading this may contribute to your employer’s 401(k) plan. And a good percentage of you also receive a matching contribution from your employer. Or if you own your own business, you can make your own contribution and be responsible for the appropriate contribution. I think you have heard of these matching employee contributions and contributions called “gift money”. Of course, we can call it and if it feels good, do it. If you’re not using your company game you’re leaving money on the table. I think that’s where the idea of ”free money” comes from. I’m not sure. At the end of the day, the reality is that you are not fully compensated.
In today’s retirement environment, the employee is (mostly) responsible for funding their own retirement. Pensions are and are going the way of the dinosaur. Today, the 401(k) is the primary investment vehicle. The average percentage of eligible employees who have balance in their 401(k) plan is 88.7 percent, and 84.9 percent contributed to their plan in 2016*.
How Much Can You Contribute To A 401k Per Year
These two points are important to keep in mind. So let’s talk about what the 401(k) Match is and why these two points above should be important to you. Like really matter.
Maximum 401(k) Plan Contribution Limits & Rules
A 401(k) match occurs when an employer agrees to “match” an employee’s contributions. This usually ranges from 3% – 6% of the worker’s compensation, or salary. On top of that, the employer can match 100%, or dollar-for-dollar, up to 25%, which would be $0.25 of the employer’s fee for every dollar of your money. Based on that, they can set a target for how much they will donate. And sometimes employers put a limit on the amount of salary they will match. Confused? Let’s break it down…
Johnny recently started working for ACME Company. They pay him $100,000 a year. ACME has a generous game. They match 100% (dollar for dollar) up to 6% of his salary.
Knowing this then we know Johnny, at the very least, should have contributed $6000 to his 401(k) to take advantage of ACME Co.’s matching plan. If he does this, then he will donate $6000 and ACME Co will also donate $6000. As we’ll see in a bit, this is a big deal.
Johnny’s sister, Jenny, works for ACME’s main competitor – The Roadrunner Inc. Jenny earns $200,000 per year. Roadrunner Inc has a generous game. They match 75% (or $0.75 per $1) of up to 5% of Jenny’s salary.
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This list gets a little tricky. First, we must calculate 5% of Jenny’s salary. So $200,000 x 5% = $10,000. Now we take $10,000 and multiply that by .75 (75%).
Boom! In order for Jenny to benefit from the matching donation for her company, she must donate $7500. And by doing that, she can multiply her contribution.
Well, now we know what the game is and we have seen some examples of how it works. Let’s address our two issues above.
This is a pretty common statement around proper donations. I would disagree though. In number one above, we know that 401(k) matching contributions are viewed as “dividends”. The truth is that our friend Johnny’s total compensation is $106,000 and Jenny’s total compensation is $207, 500. The company you work for sets a budget and allocates these dollars to you. You just won’t receive the money directly in your bank account.
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I can’t imagine any of you reading this would willingly take a dime of your money. By not taking advantage of your company’s game, that’s exactly what you’re doing.
For those of you thinking of moving to another/new company, listen up. Take a few minutes to calculate the exact dollar amount of your game. Remember, this is the money allocated to you. That way when you consider a compensation offer from a new employer, you can tell them what your actual compensation is. And at least you’ll know if their game is worse, the same, or better than your current employer.
Aside from not getting the full compensation you deserve, missing out on matching contributions can have an impact on your retirement. Let’s bring our friend Johnny back into the picture. We know he earns $100,000 and if he contributes 6% of his pay to his 401(k) he gets an additional 6% of his compensation.
What if he only contributed 3%? Well, we know at least one fact: it leaves 3% or $3000 of compensation there. On top of this, 3% miss out on opportunities for growth and development. This is important.
For 2022, 401(k) Contribution Limit Rises To $20,500
Johnny is paid 2x a month and puts $125/pay period or $250/month (12 times = $3000) into the ACME 401(k) plan. Let’s also consider ACME matches with employee contributions. So again, the ACME match is $250 x 12 = $3,000. That’s a combined $6000 per year going into Johnny’s 401(k).
As we can see above and to the right, Johnny’s investment earns 5% equity for the next 30 years and results in a net account balance of ~$416k.
Johnny is smart. In fact, he may be saving more but to simplify things our next example shows him saving the right amount to get his full amount.
. Now he is saving 6% of his $100k salary and $6000/year or $500 a month. And ACME matches $1 for $1 so that’s also $500 a month. For simplicity, Johnny’s total 401(k) contribution = $1000/month. All the variables are the same as above but before we get to it I bet this hypothetical account balance will double exactly what is above…
How Much Should You Contribute To Your 401(k)? — Missfunctional Money
The ROR is the same, the schedule is the same. We just doubled our donation amount. In the right strategy, well, you can figure that out. Now Johnny only has ~$832k because he saved 2x and got 2x more in “compensation”.
This is an achievement and his future self will surely thank him for it. He a) saved more money and b) was fully compensated for doing so.
Still not satisfied? Here is the importance of fair compensation. When Johnny contributed $6000 instead of $3000, he “earned” $3k per year in extra compensation for the game. That’s $90k over 30 years. Not a ton of money over 30 years.
But because he also invested he was able to turn that $90k into about ~$208, 000. In contrast, he was able to turn 3% of his compensation into 25% of the projected fund value.
How Much Should I Contribute To My 401k?
Have questions or not sure where to start? Let me know or make a quick call with me. The maximum employer contribution limit to an employer’s 401(k) will rise from $37,500 in 2020 to $38,500 in 2021. Currently, the maximum employer contribution limit remains the same at $19, 500 in the year 2021.
Given the increase in both employee and employer contributions, the average 401(k) contribution for each employee is $57,000. This is important since it makes your employer 401 ( k) game policy or profit share.
When an employer can contribute up to $38,500 a year, maybe a $3,000 annual 401k match isn’t very attractive. Be careful when looking for new job opportunities.
To give you an idea of what historical 401(k) contribution limits are for employees and employers, take a look at this chart compiled from IRS data.
How Much Can I Contribute To My Retirement Accounts?
As you can see from the chart, the employer contribution limit is an important part of the 401(k) contribution plan.
Therefore, every employer needs to choose an employer that has a great 401(k) match or profit sharing plan. Being able to contribute an average of $56,000 a year into retirement savings plans before taxes is huge.
During my last years of employment, my former employer contributed about $20,000 a year in profit sharing for an annual average contribution of $16,500 at the time.
Don’t look down on working for a profitable, generous employer. Working for a startup can be sexy, but most startups don’t do it and don’t even offer a 401(k).
Strategies To Maximize Your 401(k) And Top Tips
Given that less than 15% of Americans have or will receive a pension, they do not have a pension component of most American retirement plans. Therefore, we can throw pensions out of the window for the next generation.
Given that the Social Security system is underfunded by 20% – 30%, the government will either cut the average Social Security benefit by 20% – 30%, or raise the minimum age to be eligible to collect Social Security ‘in. As a result, relying on a government that has mismanaged our economy is not a wise retirement strategy.
Everyone who can afford to contribute to a 401(k) plan should. According to the Bureau of Labor Statistics, only about 55% of American workers have access to a 401(k) and only about 38% of the total workforce participates. .
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Currently, for those who participate, the average 401(k) contribution is about 6.5% of salary when employees don’t contribute.
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