Many recommend 15% of pretax income, which should only serve as a starting point. Fifteen percent of your pretax income, including your employer's match, is a good rule of thumb if you're unsure how much to contribute to your 401(k). But that is merely a generalization. The amount you need to save in your 401(k) plan will vary depending on several factors, but we'll assume for this article that your 401(k) withdrawals will be your only source of income in retirement. These factors include:
- Your retirement income sources, in addition to a pension or Rental Income.
- Your additional retirement funds, such as traditional and Roth IRAs
- Your plans for claiming Social Security
- How long do you anticipate working
- How long do you plan to live in retirement?
Main Points:
- You'll need to save less money each month for retirement the earlier you start.
- The amount you should save will vary depending on your circumstances, but generally, you should save 15% of your pre-retirement income.
- Aim to replace about 80% of pre-retirement Income with all post-retirement income sources when you stop working.
The Returns of Compound Power
You'll need to save less money each month for retirement the earlier you start. Compounding, which is essentially the returns you earn on returns, is to blame. Your returns compound more quickly once you start making money from your earnings.- If you have $2 million and expect average returns of 10%, you could retire at age 60. That is slightly less than what the S&P 500 index has produced with dividends reinvested over the past 60 years, before inflation.
- If you earn $50,000 annually, you would need to put aside the following amount in addition to your employer's match.
- If you started investing when you were 20 years old, you would need to set aside $316.25 per month, or 7.6% of your Income.
- If you began investing when you were 30, you would need to set aside $884.76 per month, or 21.2 percent of your income.
- At age 40, you would need to put aside $2,633.76 per month, or 63.2 percent of your income.
Note:
Your desire to take less risk as you near retirement will cause your expected average annual returns to decrease.Your 401(k) Investing Guidelines
These general 401(k) investing guidelines won't apply to everyone, but they're an excellent place to start when making retirement plans.Utilize the Employer Match Program
Take advantage of employer matching 401(k) contributions whenever possible, unless doing so would prevent you from paying your bills.Tip:
Your annual contribution cap is not affected by the employer contribution.Prepare To Replace Roughly 80% of Income
Aim to replace about 80% of pre-retirement income when you stop working from all sources of income, including pensions, Social Security, 401(k)s, and IRAs. Depending on how modest or opulent you want your retirement, you'll need a different amount to replace your working income. Because you won't be contributing to your 401(k) or paying payroll taxes, you can expect to spend less. Due to your lack of employment, you might also spend less on expenses like clothing and gas.The Rules of 4% and 25x
According to the well-known "4 percent rule," if you restrict your withdrawals to 4 percent of your account balance each year in retirement, your risk of outliving your retirement savings over 30 years decreases. Each year, you adjust your withdrawal amount slightly to account for inflation. By applying the same formula, you should have 25 times as much saved up for retirement as you intend to withdraw each year. You can modify your 401(k) contributions over time based on this objective.How to Calculate Your Monthly Contribution to a 401(k)
The 401(k) contribution cap for people under 50 years old is $19,500 in 2021; it rises to $20,500 in 2022. In 2021 and 2022, employees over the age of 50 may also make a catch-up contribution of $6,500. 2 Except for catch-up contributions, the total of your contributions and those of your employer cannot exceed $58,000 in 2021 or $61,000 in 2022. Few people, though, actually make these contributions. According to Vanguard's 2021 "How America Saves" report, only 12 percent of plan participants made the maximum contribution in 2020, when the cap was $19,500. Use the Social Security retirement estimator to see how much you should be saving and how much of a monthly benefit you can anticipate from that fund. You can also use a retirement calculator to determine how much additional income you'll need each month over Social Security. Decide on a calculator that enables you to customize as many elements as possible, such as your present age and account balance, anticipated contributions, other sources of income, and anticipated rates of return.Picking between your 401(k), bills, and health insurance (k)
Making 401(k) contributions is out of the question if you struggle to make ends meet each month. You might even need to take early withdrawals from your retirement account if unplanned expenses or a loss of Income arise. Focus on contributing the bare minimum to qualify for your employer's match, then use the extra funds to pay off any high-interest debt, such as credit cards.Tip:
If you're having trouble making your 401(k) contributions, one option is to select a less expensive health insurance plan. According to a TIAA Institute study, people who overpay for health insurance are 23% more likely to decline their employer's retirement match. You can lower your medical expenses and save for retirement simultaneously with a health savings account (HSA). If you have a high-deductible health plan, which frequently results in higher out-of-pocket expenses, you can only fund one. An HSA is funded with pretax funds. Your distributions are tax and penalty-free when used to pay for qualified medical expenses that the Internal Revenue Service (IRS) has approved. If you have money left over in your HSA after you turn 65, you can withdraw it without penalty for any reason; however, distributions for non-qualified medical expenses will result in income tax obligations. This makes an HSA an excellent addition to your 401(k) contributions.Frequently Asked Questions (FAQs)
How much should I have put aside to enable an early retirement?
The general rule of thumb is to replace 80% of your pre-retirement income, regardless of your anticipated retirement age. Make a careful budget of your anticipated annual expenses for retirement and multiply that amount by the desired length of your retirement. Let's say you want to retire at or around 40. In that case, when estimating your costs, you should consider things like waiting to become eligible for Medicare or Social Security benefits.How much money from each paycheck should I put into my 401(k)?
As long as you can still afford your living expenses comfortably, setting a goal of contributing at least 15% of each paycheck to your 401(k) is a great place to start. If you cannot reach this amount, it is advised that you aim for the minimum investment level at which your employer will match your 401(k) contributions.The conclusion
The amount you should save will vary depending on your circumstances, but generally, you should save 15% of your pre-retirement income. The sooner you begin making contributions to your 401(k), the less you'll need to put in overall and each month. Always aim to make enough of a contribution to qualify for the full employer match if one is offered. If not, you're wasting free money.