The best response is typically as much as you can when it comes to the topic of how much you should contribute to their 401(k) account. However, depending on your age and present financial situation, that sum can be different. The annual pre-tax contribution cap for 2022 is $20,500, while older workers may contribute more.
Most employees who contribute to a 401(k) typically put a specific amount of their salary toward the plan up to the yearly cap. The proportion of your salary that should be put into a 401(k) is typically between 10 and 15 percent, but the amount that is best for you will depend on the following three factors:
- Your years: Due to the money’s ability to grow, the earlier you start giving, the better. The higher the proportion of your salary you should contribute for the years you remain in the workforce, the less time there is between now and the time you want to begin drawing from your 401(k) in retirement.
- How much of your gross income you can afford to put toward the cause: This is especially crucial if you also have to pay for college debts, auto loans, a mortgage or rent, daycare for your children or pets, or even medical expenses.
- Having a clear understanding of your retirement plans and objectives: After retiring, you’ll need to make around 80% of your pre-retirement income in order to maintain your present standard of life. In addition to your 401(k), common sources of retirement cash outside of them include Social Security, pensions, IRAs, rental property income, and inheritances. This is known as a replacement ratio. Realistic retirement planning is crucial and may influence your choice regarding contributions.
How much money can you put into a 401(k)?
The IRS sets 401(k) contribution caps: for 2022, the cap is $20,500, with an extra $6,500 in catch-up payments permitted for employees age 50 and over.
Depending on how the plan is set up, you may be able to join your employer’s 401(k) at any time. Some plans provide enrollment on the first day of employment, while others may call for a waiting period of up to a year. Consider opening an IRA if your employer’s plan has a waiting period so you may begin saving right away.
Contributions from the employer
The IRS limits mentioned above do not include employers’ contributions for workers at companies that offer a 401(k) match. Since this is essentially “free money,” if your employer does offer a match, you should aim to contribute at least as much as the firm will match.
50 cents for every dollar saved, up to 6 percent of pay, is a typical match ratio. Therefore, if an employee contributes 6% and an employer contributes 3%, the employee will actually be saving 9% annually.
Some workers have discovered that it is wise to initially donate the maximum to an IRA and only then start making payments to their employer’s 401(k) if your employer does not match your contributions (k).
When you make 401(k) contributions, pay taxes now or later (k)
You must choose whether your contributions to your employer’s 401(k) will be pre-tax or after-tax when you join up. If your business offers a Roth option, you must also choose whether your contributions will go into a standard 401(k) or a Roth 401(k).
When you save before taxes, you postpone paying taxes on your contribution until after retirement. For instance, a worker over the age of 50 in the 12 percent tax bracket (married filing jointly) with $80,000 in taxable income will pay $3,240 less in taxes if they defer the maximum amount for 2022, which is $27,000.
When you invest in a Roth 401(k) for retirement on an after-tax basis, you pay taxes on your contributions at your current tax rate. This way, when you access the money in retirement, the withdrawals will be tax-free as long as the money has been in the account for at least five tax years.
You can benefit from both forms of contributions to vary your tax situation at retirement if your employer’s plan permits it.
Take automatic increases into consideration while calculating your contribution %.
According to Vanguard 401(k) data, the typical employee contribution to a Vanguard 401(k) plan in 2021 was 7.3% of salary. Only 23% of people who participated in 401(k) plans saved more than 10% of their income for retirement in 2021.
Many employers may let you increase your contribution percentage automatically each year (up to a maximum of 10 percent) if you can’t initially afford to contribute that much. This may be a more comfortable and progressive way to increase your contribution amount.
One of your strongest tools for planning a comfortable retirement is a 401(k). However, you might wish to take into account other options for saving in retirement.
To sum up
One of the best investments you can make for your future is a 401(k) contribution. Even if you are unable to contribute the maximum, making contributions consistently throughout your work and starting as early as you can can ensure a smooth transition into retirement.