The great thing about 401(k) plans is that they come with higher annual contribution limits than IRAs. But new data reveals that most savers aren't taking advantage of them.
In 2021, only 14% of 401(k) plan participants maxed out their contributions for the year, according to recent data from Vanguard. That meant putting in $19,500 for those under age 50, or $26,000 for those 50 and over. But that also means that the bulk of savers did not max out their retirement savings. And that's a move they might regret down the line.
It pays to max out
Hitting the annual limit on 401(k) plan contributions is no easy feat. But it pays to push yourself to max out, or to get as close as possible.
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Once you retire, you don't want to end up overly reliant on Social Security. That's because those benefits will only replace about 40% of your preretirement income, assuming you're an average earner. If you're an above-average earner, you can expect those benefits to provide even less replacement income.
Plus, Social Security cuts are currently on the table due to a projected financial shortfall. If benefits are reduced broadly, they'll provide even less replacement income.
So how much replacement income should you expect to need? While there are always exceptions, it's smart to assume you'll need 70% to 80% of your former paycheck to live comfortably once your career comes to an end.
That assumes you want to largely maintain the same standard of living. If you intend to downsize your home and downgrade your lifestyle, then sure, you might be able to manage on less. But for the most part, you shouldn't plan to retire on Social Security alone, so you'll need a strong nest egg to make sure you're able to live comfortably as a senior.
Furthermore, if you have lofty retirement goals, such as traveling extensively or living in a major city and enjoying its nightlife frequently, you may need to commit to maxing out your 401(k), at least for a period of time, to make that possible. Similarly, if you're well into your career and behind on savings (meaning, you're 45 years old with a $7,000 plan balance), maxing out is also a smart bet.
How to increase your savings rate
Maxing out a 401(k) plan is not easy. In fact, Vanguard specifically found that those who maxed out their contributions in 2021 tended to be older and have higher incomes. And let's be real -- it's easier to max out a 401(k) when you earn $250,000 a year than it is when you earn $100,000.
But if you want to set yourself up for a retirement that's devoid of financial worries, it could pay to try maxing out, or if not, at least increase your savings rate. To do so, you may need to take steps such as cutting back on nonessential spending or boosting your income with a side job (an option that, thankfully, has gotten increasingly flexible though the years). But if that's what it takes to secure your dream retirement, it'll be more than worth it.
