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5 Things To Consider When Determining Your Annual 401(k) Contribution

You may have just started a new job, became eligible for your 401(k), or decided that it’s simply time to take advantage of your company’s 401(k) options. Either way, congratulations on taking a big step towards your future. This game-changing decision is swiftly followed by one big question…

“How much should I be contributing to my 401(k)?”
After doing a quick google search you will find that most sources, including smartasset,  recommend contributing between 10 – 15% of your income towards your 401(k) each year. While this range is a good reference point to keep in the back of your mind as a general guideline, it should not be the only factor you use to determine your yearly contribution.

Your ideal contribution amount should be based on your current financial standing, age, desired retirement age, your company match, and the money you already have in different retirement accounts.

Current financial standing:

Starting to build up your retirement savings is a smart move at any age, but only if your current financial standing can support it.

Before committing to monthly 401(k) contributions, it is important to remember that this money is stowed away for your retirement. It is not meant to be a separate savings account that you can dip into whenever you choose. In fact, as of 2020, dipping into your 401(k) account before the age of 59 ½ comes with a hefty penalty charge.

Important notice: amidst the COVID-19 pandemic a stimulus bill has loosened some of the early withdrawal penalties. Read more here.

Check your emergency fund

The bottom line here is that before contributing to a 401(k), we recommend making sure that you have an emergency fund, in addition to your savings account, to fall back on in the event that you lose your job or are faced with an unforeseeable financial hardship. The “safe” amount to have in your emergency fund will vary, try using this calculator to get an estimate based on your income, expenses, and other factors.

Check your debt and interest rates

It is also important that you take your current debt into account. Did you take out student loans? Do you have any credit card debt? Maybe a mortgage that needs to be paid off? If any of these debts have high interest rates, we strongly recommend that you pay them off before starting an aggressive plan to contribute to a 401(k).

Once you are able to determine that your short-term financial goals are being taken care of, you can start focusing on building a retirement account that achieves some of your long-term goals.

How to find your ideal 401(k) contribution amount

Continue reading for 3 key factors  that will assist you in reaching a monthly contribution amount that best suits your preferences and current situation.

1: Company match

One of the first things you should ask your employer is if they offer any type of matching. If their answer is yes, then you have just opened the door to the potential to add free money to your 401(k) account.

What exactly is a company match?

If your company offers a match, what this really means is that your employer contributes a certain amount to your retirement savings plan based on the amount of your own annual contribution.

This can be done in a variety of different ways, but all match types have one thing in common by establishing a limit of how much money they will put into your account. Let’s go into an example to explain how this limit works, and how you can use a company match to maximize the money going into your 401(k) account:

  • Your company has a dollar-for-dollar match up to 5%. This means that they will contribute $1 for every $1 you put in. They have also established their limit, which is 5% of your gross yearly pay. This means that they will stop contributing that additional 1$ as soon as you are contributing a total of 5% of your gross yearly pay into your 401(k).
  • Let’s say that you make $50,000 a year at this company. If you contribute 2% of your salary to the plan – $1,000 – your employer will match this by the dollar and also put $1,000 into your plan, giving you a total of $2,000. However, if you use this same math but instead contribute 5% of your salary. Your 401(k) will end the first year with $5,000 in it, with your company contributing $2,500.

This hypothetical situation illustrates a very important point; contributing below your company match limit is leaving money (free money) on the table.

If your current financial standing does not give you the ability to reach this match, don’t worry! Focus on achieving your short-term financial goals and use that match limit as a goal that you slowly work towards month after month.

Non-elective contribution

Your company may also offer something called a non-elective match. This is different in that every eligible employee will get an annual contribution from their employer regardless of their contributions. This means that you could be contributing $0 to your 401(k) account and will still see a contribution of 3% going into that account every year from your company’s pocket.

If your company offers a non-elective contribution, this will have little impact on determining your monthly contribution amount.

2: Current age & ideal retirement age

Take a moment to think about when you would like to retire, and then look at how much time you have left until you reach your ideal retirement age.

  • Maybe you are 25 and want to retire at age 60, this gives you 35 years to save up.
  • Maybe you are 55 and want to retire at age 65, this gives you 10 years to save up.

This gap between your current age and retirement age will be a big determiner of how large your monthly contributions should be. With less time to save up, you need to start contributing a larger amount each month to have enough money in your nest egg to comfortably retire.

Age can also play a large role in how much you are able to contribute each month. For example, at age 50 you gain the ability to make catch-up contributions of up to $26,000 a year (in 2021). Before age 50 the contribution limit is $19,500 (in 2021).

The power of compound interest

The bottom line here is not to underestimate the power of compound interest. The earlier you start saving for retirement through a 401(k) account, the longer that sum of money will have to grow. This means that if you don’t start contributing until you are 40, you will have to contribute a lot more each month to make up for that lost time, and lost interest.

3: How much you have in other retirement accounts

Your overall retirement strategy can be much more than just your 401(k) account, so it is important to look at these other accounts and take inventory of their current balances so that you can determine how your 401(k) will fall into the mix.

Take an IRA for example, which is a popular savings vehicle because it allows you to save money in a tax-free or tax-deferred way. If you already have substantial assets in an IRA, you may be able to make less 401(k) contributions every month.

Looking at the big picture will give you a much better idea of how you are currently positioned for retirement.

Our advisors at Valenta Capital Management are equipped to take a deep look at your current portfolio and then use mathematical tests and scenarios to test your money against future uncertainties, such as taxes and inflation. If you aren’t sure if your current investments are enough for retirement, give us a call at (303)-951-5975

Revisiting and changing your 401(k) contribution amount

Once you feel like you have landed on a sustainable and strong contribution amount, it is important to revisit your plan as your salary changes and you grow closer to your retirement age. A general recommendation is to increase your contributions year after year.

Most importantly, don’t stop contributing to your plan, and don’t pull out any money for reasons other than retiring. Pulling out your retirement savings early will knock you over with a hefty penalty charge and rob you of the money you have worked so hard to save.

Have questions about your 401(k)?

Would you like some assistance with your 401(k) plans? We can help.

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