Tax-advantaged accounts, such as 401(k)s and Individual Retirement Accounts (IRAs), can help increase the value of your retirement savings. But exactly how much should you be contributing? After speaking with several professional financial planners, the lawyerly “it depends” wound up being the most common answer. But, let’s dig a little deeper.
A few best practices
How much you should save does depend on how much money you’ll need when you retire. However, “when you’re dealing with projections this far out, it’s kind of like throwing a ball from center field to home plate,” Scott Haley, owner of Prelude Financial, LLC in Wadsworth, Ohio said. “If you’re not a professional, it’s going to be pretty hard to hit it.” A financial planner can help you with these long-term projections, but Haley also shares a few general rules of thumb you could follow.
If you’re under 30 and can save and invest 10 to 20 percent of your income before taxes, you will hopefully be able to continue your current standard of living in retirement. The younger you are, the lower the rate, but if you’re over 30 and haven’t started at all, the number may be closer to or over 20 percent.
When you retire, maintaining your standard of living may only cost about 85 percent of what you spend today. However, you need to take inflation into account to determine how much money that will be in the future.
Get more precise by setting a goal
Contributing any amount to your 401(k) can help you prepare for retirement, particularly when you’re young and have decades to let compound interest work in your favor. However, if you want to know how much you should save and not simply follow a general rule of thumb, you may want to start by deciding on an end goal. Since the money you’re saving and investing is intended to fund your retirement, consider when you want to retire and your ideal retirement. Be realistic, though. Private jets and monthly beach vacations aren’t practical expectations for many, but an occasional trip could be. Corey Purkat, founder of Northwoods Financial Planning in Oakdale, Minnesota says he works with clients to establish a baseline. Then, they start to add or subtract items or lifestyle choices and compare the differences. Perhaps the baseline is one family trip a year; then they see what it would take to increase that to two or three trips a year.
Find your (monthly) number
With your goals in mind, you can try to determine how much money you’ll need when you retire. Then, extrapolate that out to find out how much you need to save each pay period (monthly, biweekly, etc.). You could try a DIY approach using an online retirement planning calculator or tool. Our recommendations:
Personal Capital’s free retirement planner lets you add different forms of income, various spending goals, and automatically calculates investment returns and inflation. Set your retirement spending goal and compare it to how much your savings could allow you to spend each month.
The Financial Mentor’s free retirement calculator lets you add and alter many different factors, such as how much you’d like to leave as an estate, but you’ll also need to estimate your investment returns, the inflation rate, and life expectancy on your own.
Alternatively, you could hire a financial planner to help define your goals and create a plan. Some employers offer access to this service as a free benefit to employees. Otherwise, you may have to find and hire someone on your own. If you’re looking for a one-time or occasional consultation, find a fee-only (as opposed to commission-based) financial planner that offers hourly and project rates.
Balance your 401(k) contributions with other financial responsibilities
After setting goals and finding your target monthly contribution, it’s time to put the plan into action. At the minimum, if your employer offers match, you should contribute enough to qualify for the match. However, beyond that, putting all of your savinngs into your 401(k) may not be the best option. Mark Struthers, the founder of Sona Financial in Chanhassen, Minnesota, says, “I like a mix of account types, both pre-tax and post-tax, since that flexibility can save a lot of money and headaches.” He recommends contributing to a 401(k) to maximize the employer’s match, but then focusing on other goals like paying off high-interest debt and maxing out a Roth IRA, before making additional 401(k) contributions. There are a few financial scenarios in which it should not be a priority to contribute to your 401(k): Can Contributing to Your 401(k) Be a Bad Idea? Assuming there are no major financial fires to put out, there are still limitations on how much you can contribute to a 401(k) each year without having to withdraw the excess amount (before April 15 of the following year) or pay income taxes on the money twice. In 2024, the contribution limit is $23,000, or $30,500 if you’re 50 or older. You can contribute $7,000 ($8,000 if you’re 50 or older) to an IRA each year.
Increase your contributions over time
You may not be able to save as much as your plan calls for each month, but there are tricks to increasing your contributions over time. One strategy is to wait until you get a raise, and then increase your savings rate by half of the raise’s value. You could also ease into your savings plan. Start by saving as much as you feel comfortable, and then increasing your contribution by 1 or 2 percent (of your pre-tax income) every six months to a year. Remember, the more you save now, the less likely you’ll need to play catch-up later!
Article ByLouis DeNicola
Louis DeNicola is a personal finance writer who loves helping people understand their finances and make the most of their money. You can read his work on Credit Karma, MSN Money, and Cheapism.