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How Much to Contribute to 401k

Updated on June 29, 2013
Don't overlook your 401(k) to sock money away for retirement.
Don't overlook your 401(k) to sock money away for retirement. | Source

Make Your 401k Work

If you have access to a 401k plans and are not sure how much to contribute to your 401k, or you don't think you really need to get started now, read on. Your 401k may be the most important saving tool that you have available for your retirement. Don't be casual about it. Get serious now so that things won't get serious later.

A 401k plan is one of the best ways to save money for retirement. In your plan you can defer your own money, get free money on top of that, and let it all accumulate over your working years tax deferred, meaning all of your money stays in the market to grow.

Can You Contribute to a 401k?

If you have a 401k, it means that there is a feature in the plan that allows you to contribute to it using your own money. This would happen in the form of a salary deferral directly taken from your paycheck by your employer before you even get that money. That's good news because your employer won't calculate taxes on this money, meaning it goes into your account tax free.

The real question is whether or not you can contribute. That depends on your plan's eligibility rules. Some plans will allow you to contribute the day you are hired (or with your first paycheck) while others may require to you work a month or even a year, but it won't be longer than that. Check with your employer to see what your plan's rules are to know if you can get started now.

Social Security is in Trouble!

You've probably heard this, but most people choose to ignore it. Still, Social Security is in serious trouble.

Supplementing whatever might be left in Social Security, if anything, with your own 401k or other retirement savings is critical is you want to keep your standard of living. Start now!

How Do You Start Contributing?

If you found that you are eligible to contribute to your 401k the next thing you need to do is actually get started. There are generally two possible ways to do this and the answer is a choice that your employer can make with regards to your plan.

First, you may need to enter your deferral percentage or amount into your 401k plan website. You will be given a username and password, or you will self register at the site, to gain access. You can then enter your deferral rate and your employer will automatically get that set up on your next available paycheck.

If adding a deferral rate is not an option on your plan website, expect to complete a very simple paper form to be submitted to your employer. They will take this form and enter your selection directly into their payroll system, thus making the deferral come to life.

Ask your employer to be sure you know how to setup your deferral election.

Debating how much to save? Make sure you get the full match!
Debating how much to save? Make sure you get the full match! | Source

Max Out Retirement Savings

Make sure you at least contribute enough to maximize your employer match!

How Much Do You Contribute?

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Best Contribution Level for a 401k

That is the question, and a lot depends on your plan and you.

The first way to answer this question is to know what "free money" is out there for you to grab in the way of a company matching contribution. Your plan may or may not offer you an employer match. If it does, that means that your employer will put money into your account if you put money into your account. In some cases this may be a 1 for 1 match up to a percentage like 3, 4, or even 6 percent. In others they may match half of your deferral up to some limit. If the plan offers this match, the first part to the answer of "how much to contribute to 401k" is to contribute at least enough to get every last penny of employer match that you can.

That means if your plan's match is 50% of your first 6% of deferrals, you should not contribute less than 6%. If you do, you are leaving this money on the table. Think of match money as getting an immediate return on your investment. You wouldn't turn down a 50% - 100% immediate return on a market investment would you? You shouldn't turn the match down either.

Employer match money may come with a vesting schedule, meaning the money is not yours at first but becomes your over a period of time. Don't let this bother you. Ignore it. Get the full employer match anyway. You won't believe how fast a few years can go by. Think for the long term.

The other part of the answer depends on your current retirement savings and your age. This is where you should consider working with a financial adviser to run some numbers for you. A few calculations will tell you how much you need to sock away each year to reach your retirement goals. If that is equal to or less than what you need for the employer match, then adding more is up to you. If, however, it will take more to get you to retirement, increase your deferral to that rate and reassess it on an annual basis.

Is There a 401k Limit?

Let's suppose you have the ability to contribute more. Is there a 401k limit? Well, yes, there is. The limit is set each year and is $16.500 for 2011 as it was in 2010. Each year it may change, and in the past we have seen this change by $500 or so every year or two. If you are lucky enough to be able to contribute that much to your 401k go for it.

If you are over 50 years old you get another bonus option. The government has declared that a "catch-up" contribution is possible for employees at this age and above that increases their 401k deferral limit for a year. In 2011 that was $5,500. That means that a 50 year old could contribute up to $22,000 per year in 2011. The idea here is that an older worker may find that they need to catch up to afford retirement, so they can put more money into the plan tax free.

There are certain regulatory rules that may apply to your plan that would reduce these limits for you depending on your compensation and other factors. This is because the government wants to make sure that a 401k plan is fair to all participants, so certain classes of participants may not be able to contribute to the total maximum each year. Check with your employer to see if this applies to you.

Ready to Defer Money to Retirement?

Now that you have a few basics, get going and defer the correct amount to your 401k plan. Start with the amount you need to get the employer match and increase from there if you need to contribute more to reach your retirement goals.

Now that you know how much to contribute to the 401k there is no excuse. Do it.


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