Here’s How Much You Should Contribute to Your 401(k)
We all know that saving for retirement is an essential part of your personal finance situation — but too many are either not able to or simply put it off until later. In fact, more than half of Americans say they are behind on retirement savings, according to a recent Bankrate survey. Many are attributing this to rising inflation eating away at their income and being unable to contribute more.
Moreover, those under extreme financial stress have been tapping into their 401(k) accounts to get by at higher rates than pre pandemic. With Americans both not contributing enough, as well as pulling money out of retirement — it could spell disaster in the future for those who wish to enjoy their golden years.
But how do you avoid this potential shortcoming in your retirement fund? Here’s how much you should contribute to your 401(k), and how you can maximize your nest egg for your post-working years.
How much you should contribute to your 401(k)
When it comes to retirement, you’d always like to have more than less — so ideally as much as you can. But granularly, here’s what many financial experts suggest:
- 1st step: Contribute as much as you need to get your employer match
Many employers incentivize employees to contribute to their retirement by offering a match of some sort. Typically, they will match a percentage of your overall pay. For example, if you earn $50,000/year and your employer matches 3% of your salary, they are paying you an additional $1,500 to your retirement over the course of a year.
But to get that 3%, you also need to contribute 3% of your pre-tax salary. If you don’t contribute, you’re missing out on free money from your employer. So even if you’re struggling to make ends meet, do your absolute best to capture your employer match.
- 2nd step: 15-20% of your gross salary
If you want to give yourself the best chance to maintain your current quality of life after your working years, you want to try and hit between 15-20% of your gross salary. Here’s what that looks like:
This amount that you contribute will earn compound interest over time, giving you a nice chunk of change when you decide to retire. But if you’re extremely eager about saving for retirement and want other options than your employer-sponsored 401(k), consider opening an IRA.
If you’re focused on your 401(k) for now, here’s everything you need to know about the account and what to consider.
What you need to know about 401(k) accounts
How 401(k) accounts work
The goal of a 401(k) is to give employees a chance to put away money for retirement. As pensions have become nearly extinct, 401(k) plans have taken their place as the primary way for Americans to save for retirement. But how do they work?
A 401(k) is a pre-tax retirement account where you can have dollars stashed away for retirement, before Uncle Sam takes a cut. This allows you to have more dollars working for you in the market and continue compounding. But you have to remember that the balance you have in your 401(k) won’t be entirely yours. When you take distributions, they will be taxed at ordinary income tax rates.
These accounts are valuable as you can also collect employer contributions, which go straight into your account. However, not all employers offer employer matches, so be sure to contact your HR representative to find out if there is a match.
The power of investing in a 401(k)
Investing in a 401(k) can be an overwhelming and confusing process, but there’s one concept everyone should keep in mind as they put money away: the power of time.
The money you put in a 401(k) is invested within the stock market, which over time, has historically gained value for those who are long-term investors. And the key to it is to continue putting as much money away as possible, without touching it.
Here’s what that looks like:
Let’s say you’re 28 years old and just starting to invest in your 401(k). Let’s say you make $70,000 per year, and opt to put 15% of your paycheck into retirement, which is $10,500. If you consistently do this until you’re 65 years old at a conservative 7% return, you will end up with roughly $836,000 in retirement. Of this $836,000, you only invested $283,500 — this is the power of compound interest.
If you decide to save a small amount of your paycheck or a significant portion, putting money away for retirement is a core part of financial wellbeing. As long as you have enough money stowed away in a savings account for an emergency and can afford your monthly bills, saving for retirement should be the next priority on your list.
Current is a financial technology company, not a bank. Banking services provided by Choice Financial Group, Member FDIC.
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