401k 101: How to Pick the Perfect Amount to Save for Retirement

Feb 25, 2021

The 401(k) is considered one of the most popular employer-sponsored retirement programs available.  By definition:

A 401(k) is a retirement savings plan sponsored by an employer. It lets workers save and invest a piece of their paycheck before taxes are taken out. Taxes aren’t paid until the money is withdrawn from the account. - Wall Street Journal

It was first created in 1978 and has been the go-to retirement solution for millions of people. Folks rely on this plan to provide them with security after they’ve retired from a life-long career.  Entrepreneurs can also benefit from a 401k by setting an account up with a plethora of online platformsEmployers can also use the 401(k) to distribute shares of the company among their employees, which is a great way to have additional income after retirement as well. As one of the most flexible plans available to employees, there are a number of variations including SIMPLE 401(k), safe-harbor 401(k), etc. It’s a good idea to understand all of these plans and explore the options available to you carefully before making a choice.

What to consider first

Before you try to understand how much you can or want to contribute towards a 401(k), consider how much you’re allowed to allocate. The IRS places a limit on how much money you can put into the program. These limits are mentioned below:

  • According to updated guidelines of 2017, an employee can defer $18,000 to the 401(k) plan every year.
  • Employees that are older than 50 years in age by the end of the financial year can make additional contributions, known as catch-up contributions to the plan. This amount is limited to $6,000, which allows them to contribute $24,000 towards the plan.
  • This plan allows employers and employees to contribute towards the fund together. The maximum limit for joint contribution is $53,000 for 2016 and $54,000 for 2017. The same rule applies for individuals over 50; for them the maximum allowance is $59,000

The contributions from your employer include non-elective contribution, matching contributions, and profit-sharing contributions.

How much should I contribute to my 401k?

This depends largely on the plan you choose and what you and your employer agree upon. Different financial experts have different opinions on the matter, but here are some instructions that can help you with your decision:

  • Enough to get employee matching amount – This is a good rule of thumb to follow when it comes down to planning your investment. Pay enough to gain access to employer matching funds in the plan. This is considered free money and will be a good investment for your retirement.
  • Enough to still maintain a comfortable lifestyle – Make sure you can maintain a comfortable lifestyle and splurge every once in awhile after you pay into your 401(k). If you invest too much, you can end up compromising your quality of life.
  • Enough to have regular savings, too - Remember that these funds are for your retirement and you need to save and invest money for expenses before retirement, as well. For example, if you intend to purchase a home down the line, you need to make sure you have enough savings that you can access for down payment and other obligations. The last thing you want is to have no savings and backup for current expenses.

What percentage of your salary should go to 401k?

“What percentage should I contribute to my 401k?” is one of the most popular questions among young professionals. There’s no fixed answer and different experts will offer diverse numbers. 401k percentages depend on your lifestyle, future goals, current goals, as well as age and salary. Here are some tips that can help you find the right solution:

  • What percentage of my paycheck should I put in 401k? – Ideally, as much as your employer is willing to contribute. For example, if your employer is willing to contribute around 3%, you should contribute 3% of your salary. This will bring you up to a total of 6%, which can be a good start.
  • What percentage should I put in a 401k if I want higher returns? – 10% to 15% of your salary is considered ideal by experts, especially if you receive enough income to maintain a comfortable lifestyle even after you’ve paid into the fund. This will allow your fund to be quite substantial by the time you reach retirement age.
  • How much should I contribute to my 401k if I choose the Roth 401k option? – You can pay a little less if you opt for the Roth 401k because taxes won’t be deducted when you finally withdraw your funds after retirement. However, it’s still recommended that you contribute around 5% to 10% to your funds.

Get Started

Also, consider consulting with a professional and examining your plans and requirements carefully before you make your decision.  A few of our editors curated a quick list of some great places to get started setting up your 401k.TD Ameritrade Charles SchwabE*TradeLet's get this MONEY!

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