Although many people recommend allocating 15% of income before taxes, this is merely a starting point If you are not sure about how much of your funds you should put into your 401(k), a fair rule of thumb is 15 percent of your income before taxes. This amount considers the contribution that your employer will make as well. However, that is merely a standard protocol. In this following article, we will assume that your 401(k) withdrawals will be your only source of income when you retire. However, the exact amount you need to save in your 401(k) plan is going to vary depending on several other criteria, including the following:
- Your supplementary income during retirement, such as a pension or rental income.
- If you have any, your other savings for retirement, such as regular or Roth IRAs.
- How do you intend to file for Social Security benefits?
- How long do you anticipate working each day?
- How many years of your retirement do you anticipate enjoying?
Key Takeaways
The earlier you begin putting money away for retirement, the lower the monthly amount you'll need to set aside for that goal. Although 15 percent of your salary before retirement is a fair approximate estimate for how much you should save, the actual amount you should set aside will vary depending on the specifics of your situation. When you reach retirement age, you should strive to replace around 80 percent of your pre-retirement wages with the total of all post-retirement income sources.The benefits of making compound investments
The earlier you begin putting money away for retirement, the lower the monthly amount you'll need to set aside for that goal. Compounding, which is essentially the returns you make on returns, is to blame for this situation. As soon as you start producing money off of your earnings, the rate at which your returns compound will pick up speed. Let's say you wish to retire at the age of 60 with $2 million and assume you will obtain average returns of 10%. That is slightly less than what the S&P 500 index has returned, adjusted for inflation, during the past 60 years when dividends have been paid. If you make $50,000 a year in salary, how much you will need to invest between your contributions and the matching contributions that your company will provide.- If you started investing at the age of 20, you would need to put away $316.25 per month, equivalent to 7.6 percent of your earnings.
- If you started investing at the age of 30, you would need to put away $884.76 per month, equivalent to 21.2% of your earnings.
- If you started investing at the age of 40, you would require an investment amount of $2,633.76 every month, equivalent to 63.2 percent of your pay.
Investing guidelines for your 401(k) according to common sense
Although these 401(k) investment rules of thumb won't work for everyone, they're a solid place to start off when it comes to saving funds for retirement.Make the most of your employer's matching contribution
If your employer offers a 401(k) plan with a matching contribution, you should always take advantage of it unless you really wouldn't be able to pay your bills otherwise. The contribution made by your employer will not count toward the maximum amount you are allowed to contribute throughout the year.Make a plan to replace roughly 80 percent of your income
When you quit working, you should strive to replace roughly 80 percent of your pre-retirement earnings from all income sources combined, such as Social Security, pensions, and retirement accounts such as 401(k)s and IRAs. Because you won't be required to make 401(k) or payroll tax payments anymore, you can anticipate a reduction in the amount of money you have to spend. As a result of your decision to stop working, you will no longer have to spend money on transportation and clothing. The precise sum you'll require to replace your income from work depends on whether or not you plan to live frugally or luxuriously throughout your retirement years.The 4 percent and 25x rule
If you limit the amount of money you take out of your retirement account each year to no more than 4 percent, you reduce the likelihood that you would outlive your savings within 30 years of retirement. This is the famous "4 percent rule." To consider the effects of inflation, you make a minor adjustment to the annual dollar amount that you withdraw. According to the same formula, you will need to have saved 25 times the amount of money you plan to withdraw from your income each year. Your 401(k) plan contributions can be modified over time to reflect this target amount.How to determine how much you should put into your 401(k) each month
Those under the age of 50 will be able to contribute up to $19,500 to their 401(k) plans in 2021. This amount will increase to $20,500 the following year. Workers who are 50 years old or older are eligible to pay a catch-up contribution of an extra $6,500 in either 2021 or 2022. 2 except for catch-up payments, the total amount of your contributions plus the contributions made by your employer cannot exceed $58,000 in 2021 or $61,000 in 2022. However, just a small number of people contribute these amounts. According to Vanguard's "How America Saves" report for 2021, only 12 percent of plan participants made the maximum contribution in 2020, when the ceiling was $19,500. This was the case even though the cap was increased. You can find out how much you will need to save for retirement by using the retirement estimator provided by Social Security and determining the amount of money you can anticipate receiving every month from that account. A retirement calculator is another option for estimating the amount of money you'll need each month and the amount provided by Social Security. Choose a calculator that gives you the option to customize as many parameters as is humanly possible, such as your current age and the amount of money in your account, as well as the contributions you intend to make, any additional sources of income, and the rates of return you anticipate.Choosing between your 401(k), your bills, and health insurance
It is impossible to contribute to a 401(k) plan if you cannot afford to pay the bills that come due each month. If there are unanticipated costs or a drop in income, you may be forced to take money out of your retirement account earlier than expected. If it is possible, you should prioritize putting in the bare minimum required to earn the matching contribution from your company and then use any surplus money to pay off any high-interest debt, such as credit cards. If you are having trouble affording your 401(k) contributions, one option available to you is selecting a health insurance plan with lower premiums. According to the findings of a study conducted by the TIAA Institute, individuals who overpay for health insurance are 23 percent more likely to decline the retirement match offered by their employer. A health savings account, sometimes known as an HSA, allows you to save money for retirement while contributing to your healthcare savings goals. You can only put money into one if you have a high-deductible health plan, resulting in higher out-of-pocket expenses. However, this is the only way to finance one. You put pre-tax dollars into a health savings account (HSA). If you use the money to make payments for qualified medical costs that have been approved by the Internal Revenue Service (IRS), then any dividends you get from the account are exempt from taxes and penalties. If you have unused funds left in the account when you turn 65, you may withdraw them without penalty. However, you will owe income taxes for distributions made for non-qualified medical expenses. This makes an HSA an excellent supplement to your 401(k) contributions.Frequently Asked Questions (FAQs)
How much funds do I have to save up to be able to retire earlier than expected?
Make a detailed budget of the total expenses you anticipate incurring during retirement annually. As a general rule of thumb, you should aim to have replaced 80 percent of your income before retirement by the age you expect to retire. Then multiply that number you get by the number of years you plan to spend in retirement. Imagine that you want to stop working at 40 or soon after. In such a situation, while calculating how much money you will need for your bills, you must take into consideration things like the length of time it will take to become eligible for benefits like Medicare or Social Security.How much of each paycheck should I put into my 401(k), and how often should I do it?
If you want to get a good head start on saving for retirement, you should make it a target to put away at least 15 percent of each paycheck into your 401(k) account for as long as you are still able to pay for your basic living needs without feeling financially strained. It is recommended that if you are not able to fulfill this level, you should strive for the minimum amount required for your company to match your 401(k) contribution.Putting money into your 401(k) –– the bottom line
Although 15 percent of your salary before retirement is a fair approximate estimate for how much you should save, the actual amount you should set aside will vary depending on the specifics of your situation. If you begin making contributions to your 401(k) earlier, you'll need to put away less money every month and over the course of your career. Always make it a goal to contribute enough to earn the total matching contribution from your employer if that option is offered. If you don't do that, you're throwing away free money.