If you're wondering how much you should save in your 401(k), you're not alone. Unfortunately, that can be a complicated question that depends on your personal circumstances. So while it's hard to make generalizations on this subject, one aspect of planning is nearly universal: You should take full advantage of your employer's 401(k) match.
People don't save enough
Financial planners recommend that people save 15% to 20% of their annual household income. There are certainly families that manage to bank enough of their earnings, but most Americans are falling well short of that recommendation. The average savings rate is only 3.8% right now, and it's generally been well under 10% historically.
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The 15% to 20% target isn't arbitrary. It's based on the average long-term rate of return on investments and the 4% rule for retirement account distributions.
If you're not retaining a high-enough portion of your earnings, then you're highly unlikely to build enough assets to maintain your lifestyle in retirement. Most households aren't saving enough, which means that many people will have to delay retirement or live on exceptionally tight budgets. It's unlikely Social Security benefits will expand significantly for today's working population, so most people shouldn't be counting on the government to help.
Any contributions to a retirement account are better than no contributions at all, but it's important to keep the target in mind.
How employer contributions work
Most employee benefits packages that include a 401(k) plan also offer a matching contribution of some sort. For every dollar that you save in a 401(k), your employer will also contribute a certain percentage of that dollar, up to a limit. The specific terms vary from plan to plan, so you'll have to check with your benefits administrator to understand the details.
The most common set-up is a one-to-one match of an employee's contributions, up to 6% of their annual salary. In that case, someone making $75,000 could put $4,500 in their account and receive another $4,500 from the match. Other plans might have lower caps on the employer's contributions, or the match might be $0.50 on the dollar. More complex benefits packages might have a lower threshold at which the employer contribution decreases until the cap is met.
Regardless of the terms of your benefits, employer matches represent "free money." If you're not contributing every dollar that your employer matches -- whether it's full or partial -- then you are electing to forgo a portion of your compensation. That's almost never the best course of action, and most people should be taking full advantage of any employer match.
Despite that, roughly 25% of employees who participate in a 401(k) fail to do so. On average, that equates to $1,300 of lost income annually, which is around 2.5% of the median salary. That's not enough to bring everyone up to the 15% savings rate goal, but meeting the full employer match would put many households significantly closer to an optimal level.
If you're not participating in your 401(k) program or missing out on matching contributions, then you should strongly consider adjusting your savings strategy.
Build a comprehensive retirement plan
For some people, it's helpful to exceed the employer match. The IRS allows workers to deduct up to $23,000 from their taxable income by directing those funds to a 401(k). People over age 50 can contribute an additional $7,500 in a catch-up provision. That can be a good strategy for high-income households trying to minimize taxes. Other people like the discipline imposed by automatically diverting a portion of each paycheck to a dedicated retirement savings account.
The merits of maxing out a 401(k) depend on your personal circumstances. Once funds flow into a 401(k), you do lose some flexibility. You'll generally have to pay taxes and a penalty to access those assets prior to retirement age, with a few exceptions. That's obviously not an optimal situation, and you should make sure you're building liquid assets alongside your retirement account in order to maintain control and flexibility to meet unexpected financial challenges.
Of course, a 401(k) is only one piece of the retirement planning puzzle. There are plenty of other options for your savings, including IRAs, HSAs, home equity, brokerage accounts, college savings accounts, or cash value insurance policies.
It's good to have diversified sources of cash flow in retirement, so it's important to start developing those assets early in your career. Just make sure you aren't leaving money on the table by falling short of your employer's full 401(k) match.
