401k Contribution Strategy

On your first day or after 90 days, your employer shares or emails you a brochure of their retirement plan. It is now up to you to determine how much of your salary you should contribute toward that plan. And every year after that, you must decide how much to contribute. You now have to take into account what is reasonable for you and your family to contribute to your employer’s retirement plan. Below, we will cover some strategies you can use to think about how much you should contribute to your employer’s retirement plan.

 

Let’s first discuss when you should not contribute to or limit your contributions to an employer’s retirement plan.

 

• Lack of basic necessities: If you’re struggling to cover essential living expenses, such as housing, food, or healthcare costs, it may be necessary to focus on meeting these immediate needs before allocating funds to your 401(k). Ensuring your basic necessities are met is crucial for maintaining your overall financial well-being.
• High-interest debt: If you have high-interest debt, such as credit cards or personal loans, that you are having trouble managing, it may be more beneficial to prioritize paying off toxic debt before contributing heavily to your 401(k). The interest you’re paying on the debt is likely higher than the potential returns you would earn from your retirement investments.
• Zero employer match & high-cost investment: If your employer offers a minimal or no match, you may consider alternative retirement savings options that provide more flexibility or better investment choices.

 

Now, let’s talk about how much to contribute.

Aim for at least the employer match: Many employers offer a matching contribution up to a certain percentage of your salary. It’s typically advisable to contribute enough to maximize this match. This is like free money and will add a boost to your retirement savings. This not only boosts your retirement savings but also takes advantage of the tax benefits associated with 401(k) contributions. After considering the employer match, the 4 items below are other things you should consider:

 

• Assess your current financial situation: Evaluate your current expenses, debts, and emergency funds. Ensure you have enough savings to cover any immediate needs or unexpected expenses before committing a significant portion of your income to your employer’s retirement account. People say to max out the amount you can contribute to your employer’s retirement account, but that does not consider people having conflicts when it comes to money. Life happens. And life is not perfect. This is why you should look at your entire situation. I think things like kids, starting a business, and helping loved ones can be good reasons to limit your 401k contributions.
• Account for your age and time horizon: The earlier you start saving, the more time your investments have to grow. If you’re younger, you may be able to contribute a smaller percentage of your income since you have more time to accumulate savings. However, if you’re nearing retirement, you may want to increase your contributions to catch up.
• Consider your long-term goals: Determine the level of income you would like to have in retirement and work backward from there. Financial planners often suggest saving 10-15% of your pre-tax income, including any employer contributions, throughout your career. However, this percentage can vary based on individual circumstances. Why? Financial experts generally advise saving enough to replace around 70-80% of your pre-retirement income during your retirement years. By contributing 10-15% of your income to a 401(k) throughout your working years, along with potential employer matches, you have a better chance of accumulating a sufficient retirement nest egg to achieve this income replacement goal.
• Review and adjust periodically: Regularly assess your contributions and progress towards your goals. Make adjustments as needed to stay on track, especially when experiencing major life changes like salary increases, job changes, or starting a family. I have seen clients find success by increasing their contributions every time they receive a raise. This makes it easier over time to get to the 10 -15% contribution of your income.

 

Remember, these are general guidelines, and individual circumstances can vary. It’s recommended to consult with a financial advisor who can provide personalized advice based on your specific financial situation and goals.