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How Much Should Contribute To 401k – Most of you reading this probably contribute to your employer’s 401(k) plan. A good percentage of you get matching contributions from your employer. Or if you own your own business, you can contribute and be liable for applicable contributions. I’m sure you’ve heard of these employer contributions referred to as “free money.” Sure, we can call it that, and if it sounds good, do it. If you’re not taking advantage of your company’s competition, you’re leaving money on the table. I think that’s where the idea of ”free money” came from. I can’t say for sure. At the end of the day, the reality is that you are not being paid your full compensation.
In today’s retirement landscape, the employee is (mostly) responsible for funding their own retirement. Retirement is on the way of the dinosaur. Today, the 401(k) is the primary retirement investment vehicle. The average percentage of eligible employees with 401(k) plan savings was 88.7 percent and 84.9 percent contributed to their plan in 2016*.
How Much Should Contribute To 401k
Keep these two points in mind. So let’s talk about what a 401(k) match is and why the two points above are important to you. Like really important.
Steps To Budgeting For Retirement With Your 401(k)
A 401(k) match occurs when an employer agrees to “match” an employee’s contributions. It usually ranges from 3% – 6% of an employee’s compensation or salary. On top of that, the employer can match 100% or dollar-for-dollar, all the way up to 25%, which is $0.25 in employer money for every dollar you make. On top of that, they can put a cap on how much they will contribute. Sometimes the employer puts a limit on how much they will match your salary. Confused? Let’s break it down…
Johnny recently started working at ACME. They pay him $100,000 a year. ACME has a generous competition. They match 100% (dollar for dollar) up to 6% of his salary.
Knowing this, we know that Johnny must contribute at least $6000 to his 401(k) to take full advantage of the ACME Co. matching program. If he does this, he will contribute $6000 and ACME Co will contribute $6000. As we’ll see in a moment, this is a big deal.
Johnny’s sister, Jenny, works for ACME’s main competitor, Roadrunner Inc. Jenny earns $200,000 a year. Roadrunner Inc also has a generous competition. They match 75% (or $0.75 of $1) up to 5% of Jenny’s salary.
If You Can, Increase Your 401(k) Contributions Right Now
The math here is a little tricky. First, calculate 5% of Jenny’s salary. So $200,000 x 5% = $10,000. Now we take $10,000 and multiply it by .75 (75%).
Boom! For Jenny to fully utilize her company’s matching contributions, she would need to contribute $7500. By doing that, she can double her contribution.
Well, now that we know what competition is, we’ve seen some examples of how it works. Let’s talk about our two points above.
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This is the most common statement around matching contributions. I have to disagree though. In point number one above, we know that 401(k) matching contributions are viewed as “compensation.” 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 has budgeted and allocated these dollars to you. You will not receive the money directly in your check.
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I can’t imagine any of you reading this would voluntarily take less money out of your paycheck. By not taking advantage of your company’s relevance, in essence, that’s what you’re doing.
For those of you considering switching to another/new company, ask away. Take a few minutes to calculate the actual dollar amount of your match. Remember, it’s money earmarked for you. When you’re considering compensation offers from your new prospective employer, you can tell them what your actual compensation is. At least you know if their fit is worse, the same, or better than your current employee.
Apart from not getting the full compensation you are entitled to, missing the matching contribution will affect your pension. Let’s bring our friend Johnny back into the picture. We know he earns $100,000, and if he contributes 6% of his salary to his 401(k), he gets an additional 6% of his compensation through the match.
What if he contributes only 3%? Well, we know at least one fact: He leaves 3% or $3000 in compensation right there. Above that, 3% misses growth and compounding opportunity. This is important.
How Much Should You Contribute To Your 401(k)?
Johnny gets paid 2x a month and puts $125/pay period or $250/month (time 12 = $3000) into the ACME 401(k) plan. Let’s keep ACME contests along with employee contributions. So again, the ACME match is $250 x 12 = $3,000. That’s a total of $6000 a year for Johnny’s 401(k).
As we can see above and to the right, Johnny’s investment earns a very steady and consistent 5% for the next 30 years and leaves a hypothetical account balance of ~$416k.
Johnny is smart. In fact, he may be saving too much, but to keep things simple, the next example shows him saving just the right amount to get his full payoff.
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. Now he saves 6% of his $100k salary, which is $6000/year or $500/month. And ACME matches $1 for $1, which is also $500/month. For simplicity, Johnny’s total 401(k) contribution = $1000/month. All the variables are the same as above, but before we get to that, I bet this hypothetical account balance will be twice what it was above…
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The ROR was the same and the duration was the same. We doubled our contribution amount. In a linear formula, you can find it. Now Johnny has ~$832k because he saved 2x and got 2x the “compensation” that applies to him.
It’s a win-win and his future will surely thank him. He a) saved more money and b) got his full compensation out of it.
Still not convinced? Here’s how important matching compensation is. When Johnny paid $6000 instead of $3000, he “earned” $3k a year in compensation from the competition. That’s $90k over 30 years. Not a ton of money in over 30 years.
But because he also invested it, he was able to turn that $90k into almost ~$208,000. In other words, he was able to turn 3% of his compensation into 25% of his hypothetical account value.
The Irs Just Announced The 2022 401(k) And Ira Contribution Limits
Have questions or don’t know where to start? Let me know or book a quick call with me. The maximum employee 401k contribution for 2019 is $19,000, and increases by $500 a year every two years. Since the median household income is approximately $60,000, a household would need to contribute 31% of their gross income to contribute the maximum.
The average American household savings rate is only 6% per year, so clearly, maxing out a 401k is no easy feat. However, know that if you max out your 401k over the years, you will accumulate more money than you can imagine.
Check out the chart below to see what your 401k potential balance will be after several years. Check the right-hand column to see what the best 401k amount is by age due to market returns and company matching.
Now that you agree that maxing out your 401k is a smart move, especially since you can’t rely on Pension and Social Security, let’s look at some strategies that will allow you to maximize your 401k.
How Much Should I Contribute To My 401(k) Plan?
1) Automatic deduction from every paycheck. The key is that you pay yourself first by choosing a percentage of your paycheck that will automatically be deducted from your 401k contribution. If your salary is actually $60,000 a year, choose the 31% automatic deduction. Since the deduction is pre-tax, the pain of contributing 31% of your gross salary to your salary is greater than the feeling of losing 20% of your salary. I promise you will get used to living comfortably on a low income.
2) Total contributions at the end of the year. If it’s customary to receive a year-end bonus, you can always elect to set aside a percentage of the bonus to grow your 401k. Bonuses are generally taxed at the top income tax rate because the IRS treats your bonus check as a regular payment. For example, if you receive a $20,000 bonus, the IRS may think you earn $20,000 X 52 weeks = $1,040,000!
3) Contribute in a mixed manner. If cash flow is a bit tight, you can at least contribute the company matching amount with your paychecks and then max out your 401k with your year-end bonus. This way, you can breathe easy if you have unexpected emergency expenses.
4) Always contribute at least
Average 401(k) Balance By Age
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