Personal Finance

How Much Should I Contribute to 401(k)?

Participating in a 401(k) plan offered by your employer can be a great way to build retirement savings. A 401(k) is packed with valuable tax breaks, and many employers kick in a contribution if you put some of your salary in the plan. But you are the main funder of your 401(k) and knowing how much you should contribute to your 401(k) is an important step in a solid retirement plan.

What's the Maximum I Can Contribute to My 401(k)?

In 2018 anyone younger than age 50 can contribute up to $18,500. If you're older you are eligible to make a "catch up" contribution that boosts your annual limit to $24,500. Those limits are adjusted periodically to keep up with inflation.

I Can't Afford to Contribute the Annual Maximum, What Should I Contribute to My 401(k)?

Don't beat yourself up if your budget can't (yet) handle socking away the annual maximum. Another way to think about how much to contribute to your 401(k) is to aim to save a percentage of your salary. Contributing at least 10% to 15% of your annual salary will put you in good shape to have the money needed to pay living expenses in retirement.

That might sound like a lot, but consider that if you retire at 65 you might need your retirement savings to support you 30 years. One of the best steps you can take today is to have a clear-eyed understanding of how much you need to save for retirement. Chances are, it's more than you think.

Many 401(k) plans offer a neat feature that can help you commit to saving more over time. Check to see if your plan offers "auto-escalation" where you agree to have your contribution rate increased annually—typically by one percentage point—or when you get a raise. If you have that feature, sign up. If not, pick a memorable date—your birthday—and set up a calendar reminder to boost your contribution rate.

You might also consider committing a portion of each raise to boost your 401(k) contribution rate. For instance, make a pact with yourself that you will save half of each salary bump. So if you get a 4% raise, immediately raise your 401(k) contribution rate by 2 percentage points.

My Plan Automatically Enrolled Me and Set My Contribution Rate at Less Than 10%. Do I Need to Save More?

It's common for plans to automatically enroll new workers in a 401(k) plan at a low contribution rate of just 3%. That's not ideal, as your goal should be to get to 10% as fast as possible.

Moreover, if you were automatically enrolled in your plan, your contribution may be so low you aren't earning the maximum matching contribution you're eligible for.

Most employers that offer a 401(k) also give employees a matching contribution if they participate in the plan. Each 401(k) has its own formula for how its match works. One common match is that employers will kick in a maximum 50% match up to the first 6% of salary an employee saves. Translation: If you save 6%, your employer will contribute another 3%.

But here's the quirky thing: Plenty of 401(k) plans automatically enroll new workers at a contribution rate that is too low to qualify for the maximum employer match. If your match is 50% on the first 6%, you're only going to get a 1.5% match from your employer if you are contributing 3% of your salary. If you contributed 6% you would get the maximum 3% match.

Contact your HR department, or your plan administrator and ask what your contribution rate needs to be to earn the maximum match. It's a snap to have payroll adjust your contribution rate.

Should I Keep Contributing to My 401(k) Beyond What I Need to Get the Maximum Match?

There are plenty of good reasons to do all of your retirement savings in a company 401(k) plan. Federal regulations require a 401(k) to be operated in ways that are in the best interests of the participants, including keeping fees low. If you work for a large company with at least a few hundred employees chances are your 401(k) keeps costs low and offers you a solid lineup of investment choices.

Moreover, the simplicity of having your contributions automatically sent over to your 401(k) account with each paycheck is a fantastic way to stay on track. It's out of your hands!

Many 401(k) plans also now offer participants a choice of saving in a Traditional 401(k) or a Roth 401(k). A Roth 401(k) offers the same tax deal as a Roth IRA: your contributions are made with after-tax dollars, but in retirement every penny you withdraw will be 100% tax free.

While there are income limits for contributing to a Roth IRA, absolutely anyone can enroll in a Roth 401(k) when it is offered, regardless of income. (That said, if you save in a Roth 401(k) your employer will still make the matching contribution into a Traditional 401(k) account. Just another quirk of how 401(k) plans work.)

If you want to save in a Roth, but your employer doesn't offer a Roth 401(k) option, you might consider contributing enough to your 401(k) to earn the maximum matching contribution, and then focus additional retirement saving in a Roth IRA.

Or do both! Given the high cost of retirement, saving as much as you can in your 401(k) and an IRA will go a long way to helping you enjoy a secure retirement.

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Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.

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