Setting up your 401(k) contributions isn't rocket science, though it can feel that way, especially to those who aren't sure how much retirement will cost. There isn't a universal magic number, but there are a few pretty simple strategies you can use to come up with your retirement savings number right now.
Here's a closer look at a few approaches you can use to decide how much you want to contribute to your 401(k) going forward.
A good starting point: Get your full employer match
If you're starting a new job and your employer asks how much you want to defer to your 401(k) from each paycheck, your answer should be at least enough to get your company's full match. That assumes it offers one, of course. These funds are basically like a bonus for you, but you have to contribute to your retirement account in order to claim it.
Each company has its own matching structure that determines how much it will contribute to your 401(k). Usually, this involves a dollar-for-dollar match or a $0.50 on the dollar match up to a certain percentage of your income. If your company does a $0.50 on the dollar match up to 6% of your salary and you earn $50,000 per year, you would contribute 6% of your salary, or $3,000. Then, your employer would match half of this, contributing another $1,500 on your behalf. You're free to contribute more if you want, but you're on your own from there.
If you're unsure how your company's 401(k) match works, ask your HR department to find out. Then, make sure it's feasible for you to contribute enough to get your full employer match. If doing so would make it difficult to pay your bills right now, scale your contributions back. The solution below may work better for you.
The bare minimum: Start with 1% of your salary
If your company doesn't offer a match or you cannot afford to contribute enough to get the whole match, start with 1% of your salary. For someone earning $50,000 per year, that only adds up to $500. If you're able to afford more than that, bump it up to 2%, and if you're still comfortable with that, try 3%, and so on. Keep going until you find the highest percentage you feel you can comfortably save.
Even if that's only 1% right now, it's better than nothing. Using our previous example, if you contribute $500 per year for 30 years and earn a 7% average annual rate of return, you'd end up with over $47,000. That's not enough to retire on, but it's not a small chunk of change either.
Just start with whatever you're able to do and set a goal for yourself to increase your contributions by 1% of your salary every year until you get to where you want to be, whether that's getting your full employer match or hitting a certain amount you determine using the strategy below.
The ideal: Create a custom retirement plan
The only way to know if you're contributing enough to your 401(k) is to make a retirement plan. This helps you estimate how much you'll spend and also tells you how much you need to save monthly to retire on time.
The first step is to determine how long your retirement will last. Estimate your life expectancy and figure on the high side -- at least 90 -- unless you have a health condition you believe will shorten your life. Then, subtract your chosen retirement age from this age.
Next, estimate your annual retirement expenses. If you don't anticipate your lifestyle changing a lot between now and retirement, you can use your current budget as a starting point. But if you do expect a different lifestyle -- for example, if you plan to move elsewhere -- you may have to do some more research to get a sense of what your living expenses might be.
For the next steps, it's probably best to use a retirement calculator unless you're really good with math. Plug all the above information into your calculator. If it asks about inflation rate, use 3% per year. For your investments, use a 5% or 6% average annual rate of return. Your money may grow faster than this, but you don't want to be too optimistic in case it doesn't.
This should tell you the total cost of your retirement and how much you need to save per month to get there, but you're not quite done yet. You will probably get some money from Social Security, and maybe an employer 401(k) match. That reduces how much you must save on your own.
Estimate your Social Security benefit by creating a my Social Security account. You may want to plan to receive about 75% of this if you're worried about potential benefit cuts in the future. Some retirement calculators enable you to enter your estimated Social Security benefits when you input all your other information. Then, it will take this into account when figuring out how much you must save on your own.
You should know how much you're getting for a 401(k) match, or you can find out by checking with your HR department. Subtract this amount from your monthly savings goal to figure out what you must save personally. Aim to set aside at least this much every month if you can afford to do so.
Starting with your employer match or a set percentage of your salary may work for you for the time being, but don't assume it's the best strategy for the long term. You should reevaluate your retirement contributions at least once per year, even if you've already created a custom retirement plan. Things can change over time, and routinely revisiting your retirement plan is the only solid way to keep yourself on track.