There's no hard and fast rule for how much of your salary you should put into your 401(k) account. But, in general, you should always consider contributing as much as possible, depending on your specific financial circumstances.
A combination of factors will dictate how much you should personally save, including:
- How much of your take-home pay you can afford to set aside
- Your age
- Whether you think your retirement savings are on track to meet your goals
- How close you are to retirement
- Contribution limits — for 2020, the IRS permits a maximum pre-tax or Roth employee contribution of $19,500, with an additional $6,500 catch-up contribution for individuals who are age 50 or older at any time during the year.
Increasing your 401(k) contributions can add up
Over time, even a seemingly small percentage difference in your savings rate can make a big difference.
Total amount accumulated over 30 years, based on a hypothetical annual salary of $75,000
Source: AARP 401(k) Savings & Planning Calculator
Footnote: Dollar figures are rounded to the nearest hundred. This illustration assumes a salary of $75,000, pre-tax contribution rates of 6% and 10%, with those contributions made at the beginning of the month and a 6% annual effective rate of return. Hypothetical results are for illustrative purposes only and are not meant to represent the past or future performance of any specific investment vehicle. Investment return and principal value will fluctuate and when redeemed the investments may be worth more or less than their original cost. Ordinary income taxes are due upon withdrawal. Withdrawals prior to age 59½ may also be subject to 10% additional tax, unless an exception applies.
A number of people have benefited from saving and investing as much money as possible in a 401(k) account, within certain limits.
Know your maximum contribution limit
Start by understanding how much you're allowed to contribute, and work back from there. Your maximum contribution limit depends on how old you are. In 2020, if you're under age 50, you can contribute up to $19,500; those age 50 or older by the end of the year can contribute up to $26,000 for 2020 ($19,500 plus an additional $6,500 in catch-up contributions), as long as your employer's plan permits catch-up contributions. These limits, by the way, do not include any contributions your employer might provide. The combined employee-employer contribution limit for 2020 for defined contribution plans is $57,000, or $63,500 for individuals eligible for catch-up contributions (if plans permit).
Take advantage of company matching
If you are fortunate enough to have an employer that offers to match your 401(k) contributions, consider contributing at least as much as the percentage your company will match. Say your employer will match up to 6% of your salary — then aim to contribute at least that much, if you can, to take full advantage of the benefit.
Consider Roth 401(k) Contributions
Matching contributions are essentially free money, and you may want to take advantage of them while you can. Making your contributions as Roth contributions that are held in a Roth 401(k) account may be a good option if your employer offers it. Qualified distributionsFootnote 1 from a Roth 401(k) account are federal income tax-free, which can help to reduce your tax burden in retirement.
"Matching contributions are essentially free money, and you may want to take advantage of them while you can."
— Ben Storey, Director, Retirement Thought Leadership, Bank of America
Create an emergency fund so you won't have to tap your 401(k) account early
Before maxing out your contributions, make sure you have money set aside in an emergency fund — three to six months' worth of living expenses is generally considered enough — as well as whatever you need to cover short-term goals like paying off debt and loans. You don't want to be caught in a situation where you're forced to withdraw funds from your 401(k) account before age 59½. In that case, your withdrawal will generally be taxed as ordinary income and may be subject to a 10% additional federal tax, unless an exception applies.