How Much Should I Contribute to My 401k?
Using your company's 401(k) plan to save for retirement lets you stash away money that grows tax-free as long as it stays in the account. However, with such large annual limits -- $17,500 if you're under 50 and $23,000 if you're 50 or older as of 2013 -- it's challenging to figure out the "right" amount to contribute each year. "As with any sound financial planning advice, it depends upon the individual's situation," says Anika Hedstrom, an MBA and Senior Financial Analyst practicing in Southern Oregon.
Maximize Your 401(k) Match
Figuring out how much of your contribution your employer will match is a good starting point for determining how much to contribute. "Generally, it is wise to contribute at least enough to receive the full amount of the company matching policy," suggests Hedstrom. "If you don't contribute the amount needed to receive the maximum amount of company matched dollars, you are throwing away free money." Check with your 401(k) plan administrator to figure out how your company figures the match. Often the match is expressed as a percentage of your contribution, up to a percentage of your salary. For example, the company's match might be 30 percent of up to 10 percent of your salary. If you make $50,000, that means your company will chip in 30 cents for every dollar you contribute, up to $5,000 of contributions.
Larger 401(k) Contributions Without Max
If your employer doesn't offer a matching contribution, you should consider contributing even more. "If you do not receive a company match, then it is even more important to contribute as much as possible, up to annual maximum contribution limit," suggests Hedstrom. While Hedstrom recommends maximizing your contributions up to the annual limits, she doesn't suggest contributing so much that you're unable to pay for your other budgeted expenses.
Avoid Contribution Reductions
Hedstrom warns that reducing your 401(k) contributions shouldn't be taken lightly. "If you have based your contributions on a budget and you have sufficient emergency savings, you should not need to lower contributions. It is very important to have some liquidity for emergencies and unexpected expenses. If you do not have a rainy day/emergency fund, then make that your primary focus," she says. But, once you've started making contributions, lowering them can affect your taxes as well as your nest egg. "Contributing before-tax dollars to a 401(k) plan lowers an individual's effective tax rate," says Hedstrom. "By contributing less, you may potentially have more of your salary allocated to taxes than compounding tax-free in a retirement account."
Increase 401(k) Contributions Over Time
Even if you can't maximize your contributions at the start, ask your employer to increase the percentage of your paycheck that gets contributed each year. "Most retirement administrators have automated programs where an individual can elect to increase the percentages of their contributions on an annual basis," according to Hedstrom. "More than likely the 1 or 2 percent annual increases are inconsequential to you now, but they pay off immensely in the long run."
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