Deciding how much to save in your 401(k) shouldn't take an advanced degree in mathematics.
At a minimum, you should contribute as much as your employer will match to your 401(k). If you're able to put away even more for retirement, you can contribute up to $22,500, or $30,000 if you're older than 50, in 2023 (or up to $20,500 or $27,000, respectively, in 2022).
There are a few other considerations to take into account before plowing all that money into your 401(k), but here's what you need to know.
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Take advantage of employer matching
At a minimum, you should contribute enough to your 401(k) that you're taking full advantage of your employer's matching program.
For example, if your employer is willing to match all of your contributions up to 4% of your salary, then you should do everything you can to contribute at least that amount. Not doing so is the same thing as agreeing to a salary reduction; you're simply refusing part of the compensation you're entitled to.
An important factor to consider is that many employers dole out the 401(k) match based on your contribution for each pay period. So if you temporarily halt contributions to your 401(k) for a few months to handle an emergency, you might not be able to get those salary matches back by contributing extra in the last few pay periods.
Likewise, if you defer a big chunk of your paycheck early in the year and max out the contribution limit,you might forgo matching contributions later in the year. Talk to your HR department to see what the policy is.
Employer matching is the way many people turn relatively small amounts of their salary into a large retirement nest egg. Let's say you make $60,000 and your employer matches up to 4% of your salary. That means you're contributing $2,400, but $4,800 is going into your account.
Over a 35-year career, assuming 2% annual salary increases, you could end up with a 401(k) balance of $900,000, assuming 7% average annual returns (a historically conservative estimate). With good market performance, you could even get to $1 million or more.
Max out your contribution
While that sounds like a lot of money from a 4% contribution, it may not be enough to sustain the lifestyle you want in retirement. Based on the often-used "4% rule" for retirement and using the preceding example, a $900,000 nest egg would safely produce $36,000 in annual income in retirement. Withdrawing any more than this greatly increases the chances you'll eventually run out of money. Even when you factor in Social Security,it might not be enough.
Fortunately, you can save more than your employer is willing to match -- a lot more, in most cases.
One popular strategy is to increase your contributions by 1% per year until you hit the maximum amount you're comfortable with saving. Any small increase can make a big difference. Returning to the example, consider how small increases in elective contributions affect retirement savings in the long run.
| Your Contribution (% of Salary) | Employer's Contribution | Account Value After 35 Years |
|---|---|---|
| 4% | 4% | $900,869 |
| 5% | 4% | $1,013,478 |
| 6% | 4% | $1,126,087 |
| 7% | 4% | $1,238,686 |
| 8% | 4% | $1,351,305 |
There are even more opportunities to invest beyond a 401(k), such as an IRA. However, you should be sure to capture your employer match on your 401(k) first.
Catch-up contributions
If you're older than 50, the IRS gives you a way to save even more money in your 401(k). For 2022, the catch-up contribution allows older workers to put away an extra $6,500 in their 401(k) on top of the standard annual wage deferral. In 2023, the catch-up contribution increases to $7,500.
You can make catch-up contributionsat any time during the year you turn 50. There's no need to wait until your birthday to ask HR to increase your contribution.
If you're a late saver or just want to max out your tax-advantaged savings, catch-up contributions are a great tool. If your salary in your 50s has increased to the point where you can contribute more than $20,000 to your retirement savings, you're also likely saving a lot in taxes by contributing. Deferring taxes until retirement, when your tax rate will likely be lower, could save you thousands of dollars, but individual circ*mstances will differ.
Before you even start down the path of how to invest your money in a 401(k), the key is to save. 401(k)s, given their company matches and high contribution limits, are a great place to start. Consider building up to the maximum annual contributions, and your nest egg will take care of itself.
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As a financial expert with a deep understanding of retirement planning and investment strategies, let's delve into the key concepts presented in the article about deciding how much to save in your 401(k).
Employer Matching:
The article emphasizes the importance of taking full advantage of employer matching in your 401(k). This is a critical point, and I wholeheartedly agree. Employer matching is essentially free money that can significantly boost your retirement savings. The example provided, where a 4% contribution from both the employee and employer leads to a substantial nest egg over a 35-year career, vividly illustrates the impact of this benefit.
Contribution Limits:
The article mentions the maximum contribution limits for 2022 and 2023, with individuals under 50 being able to contribute up to $20,500 (2022) or $22,500 (2023), and those over 50 having catch-up options of $27,000 (2022) or $30,000 (2023). It's crucial to understand these limits and consider them when planning your contributions to ensure you maximize the tax-advantaged benefits of your 401(k).
Strategic Contribution Planning:
The article proposes a strategic approach to contribution planning, suggesting a gradual increase in contributions over time. This is an excellent strategy for individuals who can afford to contribute more than just enough to get the full employer match. The table provided illustrates how even small increases in elective contributions can substantially impact retirement savings.
Catch-up Contributions:
For individuals aged 50 and above, the article introduces the concept of catch-up contributions, allowing an extra $6,500 (2022) or $7,500 (2023) to be contributed to the 401(k). This is a valuable tool for late savers or those seeking to maximize their tax-advantaged savings as they approach retirement.
Tax Advantages:
The article briefly touches on the tax advantages of contributing to a 401(k), mentioning the potential tax savings by deferring taxes until retirement when the tax rate is likely to be lower. This aligns with the broader strategy of tax-efficient retirement planning.
Importance of Saving:
The overarching theme of the article is the importance of saving for retirement. It emphasizes that, regardless of investment strategies, the first step is to save. 401(k)s, with their employer matches and high contribution limits, are highlighted as an excellent starting point for retirement savings.
In conclusion, the article provides a comprehensive guide for individuals navigating the complexities of 401(k) contributions, emphasizing the significance of employer matching, contribution planning, and the various strategies available to optimize retirement savings.
