How much should I put in my 401(k)?
If you’re fortunate enough to have an employer who offers a 401(k), you should seriously consider participating. A 401(k) allows you to lower your tax bill and potentially build wealth through the stock market. Here’s how to figure out how much you should contribute.
The power of the employer match
You should contribute at least enough to fully take advantage of your employer match if you are offered one. If you don’t do that, you are simply leaving money on the table! For instance, your employer may match 100% of your contributions up to 5% of your salary. That means if you make $40,000 and contribute 5% of your salary ($2,000), your employer will contribute an additional $2,000. You are effectively doubling your money before anything happens in the stock market. If I came up to you and guaranteed that I would double your money if you invested with me, would you take me up on that?
Reasons to contribute more than the employer match amount
Should you stop there or contribute more than your employer match amount? Well, that depends on how much you have already saved. A good rule of thumb is to have one times your salary saved by age 30, three times by 40, and six times by 50 for retirement readiness. If you are running behind, you should probably try to contribute more than the employer match amount. Another important factor to consider is your goals. At what age do you want to retire? What type of lifestyle do you want in retirement? It may be necessary to increase your 401(k) contributions to reach your goals.
Small contributions can make a big difference
Contributing to your 401(k) and foregoing that money from your paycheck can seem tough. However, it’s important to contribute whatever you can, especially if you are young and have plenty of time to experience compound investment returns. For instance, based on the historical average of stock market earnings, contributing just $50 a month would grow to an estimated $100,000 in 30 years ($200,000 if those contributions were matched by the employer)! You should consider increasing your contributions as you get older and your income increases. A good rule of thumb is to start by contributing the employer match amount and then increase your contributions by one percent a year.
A 401(k) can be a powerful tool to save for retirement. If you’re not sure how much to contribute, don’t get frozen with indecision and miss out. Just go with your gut and see how it goes; you can always make adjustments later if necessary.
James Mwombela is a Certified Financial Planner™ professional who helps clients make educated financial decisions in order to live their best lives. He began learning everything he could about managing finances during college in order to have more financial stability than he experienced growing up. He became determined to share this knowledge with others so they could experience the same confidence and freedom of choice.