How Much Should I Have in My 401K
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At some point, everyone has that moment of panic thinking about retirement. The fact is that it’s not easy to save and make sure you’re on track to retire comfortably the day you stop working. And it’s terrifying to think you are behind in your retirement planning efforts.
The good news is that it’s easier than you might think to get yourself on track for retirement, even if you are currently behind. Now is a great time to review your 401k and figure out if you should be putting more into this tax-friendly investment vehicle to get a better rate of return.
What Is a 401k?
A 401k is a type of employer-sponsored retirement plan that investors use to build nest eggs. Usually, you’ll be able to access your 401k account through a stock broker like Fidelity, Charles Schwab, or TD Ameritrade.
In short, a 401k allows you to allocate a portion of your annual salary so that it can grow tax-free until you retire.
A 401k is an excellent way to save money long-term without paying immediate taxes on your earnings. So, if your employer offers this type of solution it’s in your best interest to explore it. This could be one of the most important decisions you make in life. Depending on how much money you put into your account, you may be able to lower your tax rate by dropping into a lower tax bracket.
That said, here’s a disclaimer: Like any other investing account, your 401k can decrease over time if you make poor investment decisions or the overall market tanks. Before making a decision on how to invest your funds, do your due diligence, and develop an investing strategy that helps you achieve your goals.
The Benefits of a 401k
Contributing to a 401k is a no-brainer when considering the abundance of opportunities they afford. Here are some of the top benefits that come with using a 401k.
Retirement Income
Unless you want to work until your last dying day, you’ll have to plan ahead and figure out how you to earn annual income when you stop working.
Of course, most working Americans are eligible for Social Security at a certain point in their life. However, the fact is that Social Security typically does not provide enough to live on during retirement years. Most people treat Social Security as supplemental income to help pay for things like rent, mortgage payments, and groceries.
Putting money into a 401k can provide valuable retirement income to help you live a better lifestyle when your primary earning years are over.
Tax-deferred Growth
One of the best reasons to put money into a 401k plan instead of a high-yield savings account or brokerage account is that the money can grow on a tax-deferred basis until you start making withdrawals. Once you begin making withdrawals from your 401k, the money is taxed as ordinary income.
By avoiding paying taxes while the money is in your 401k, the funds are able to grow at a much larger rate — the money that would normally go to taxes is busy earning compound interest or returns. Over the course of your career, the returns can add up significantly. And if you play your cards right, you could wind up with a hefty sum of money when it’s time to take your money out.
Employer Match
In addition to tax benefits, you may be able to benefit from employer contributions, too. Some employers offer matching programs, essentially giving you free money in addition to your annual salary. Maximizing employer matches can be an excellent way to get more value out of your full-time job so that you can sock away more toward retirement.
TIP: You should aim to at least contribute to get your employer match. It’s free money!
How Much Should I Contribute to My 401k
Every investor is different in terms of earning potential and personal finance goals. If you want an accurate assessment, the best thing to do is consult with a certified financial advisor who is able to take a close look at your portfolio and determine whether you are on track for retirement.
That said, as a general rule of thumb, you should aim to have the equivalent of roughly one year’s salary saved in your 401k by the time you are 30. So, if you make $60,000 per year, you should have $60,000 socked away in a tax-deferred account.
This can be achieved by setting aside 15% to 20% of your annual salary each year while also leveraging employer contributions. If you take this approach and set aside a healthy annual contribution amount each year, the money is going to add up over time and turn into a strong account balance. Take my word for it.
Having $60,000 or more set aside for retirement at 30 may seem like a lot of money. But it’s important to remember that’s the combination of base contributions in addition to investment returns and interest. If you invest your money in the funds, it’s possible to stretch your funds much further than if you had it stashed away in a checking or savings account.
Building a Savings Lifestyle
It’s important to be honest with yourself when planning for retirement. For example, you may take a look at your annual salary and find it far too difficult to set aside 15% or more of your annual salary for retirement savings.
The truth is if you’re saddled with student loans, credit card debt, car payments, and other bills, it can be a challenge to save up enough money for retirement. That said, there are some things you can do to start saving more.
Start by making a budget. Look for areas where you may be spending money frivolously. For example, maybe you are eating out too much or spending more than you should on things like clothes, accessories, or travel. Consider removing certain expenses or cutting back on spending to start setting more money aside.
The path to financial independence can be difficult. But with a little bit of training, you can build greater austerity into your daily life without too much pain. You’ll find you can probably get by with less than you think while still living a happy and comfortable lifestyle. Keep in mind that the more you save now, the more money you have to spend later.
401k Contribution Limits
It’s also important to remember that there is a limit to how much you can contribute to your 401k each year. Starting in the 2020 tax year, the contribution limit is $19,500 — an increase of $500 from the previous year.
If you exceed your annual 401k contribution limits and you have money left over, there is more that you can do to let your money grow tax-free. For example, most investors choose to use 401ks in conjunction with individual retirement accounts (IRAs) and Roth IRAs. These types of accounts have lower contribution limits ($6,000 combined; $7,000 if you’re over 50 years old). However, they are excellent for retirement savings and planning for future growth.
In addition, you may also want to consider setting up a flexible life insurance policy that can provide tax-deferred growth with living benefits.
Maxing out your retirement accounts is a fantastic way to save money and something that all savvy savers do.
How to Invest Your 401k
Not all companies allow you to manage your 401k plan. However, some companies provide self-directed options for employees who want more control over allocation and disbursement.
As a word to the wise, if your company offers a self-directed or brokerage option, you should take full advantage of this opportunity. You are going to have more freedom and flexibility to take control of your personal capital and plan ahead for retirement.
Here are some of the types of investment opportunities you should consider for your 401k.
Index Funds
An index fund is a type of investment that follows a particular benchmark like the S&P 500. Index funds are usually passively managed, meaning they are automated and designed to track specific markets. You can purchase low-cost, high-performance index funds from a company such as Vanguard, Charles Schwab, or Fidelity.
Mutual funds
Like index funds, a mutual fund is a type of financial solution made of securities like bonds, stocks, and money market instruments. Mutual funds are typically actively managed by fund managers. They can be higher risk and are designed to beat markets instead of tracking them, but keep in mind that they come with higher fees for that management and there’s no guarantee they’ll outperform.
ETFs
ETFs track underlying indexes and contain various investments, like stocks, commodities, and bonds. They are bought and sold throughout the day and are highly liquid.
Individual Stocks
You should also consider purchasing individual stocks for your 401k. Just remember that stocks can be highly volatile, meaning they can fluctuate considerably in value — especially over a 20- to 30-year cycle.
Your best bet is to focus on diversification. Build a portfolio that provides both opportunities for growth and for long-term stability.
401k Tips for Investors
It’s important to manage your 401k and understand exactly how the investment process works. Here are our top tips for investing in your 401k.
Keep Close Tabs on Your 401k Account
Oftentimes, employees sign up for 401k accounts and rarely check into them. This is a mistake. Planning for retirement may seem like a far-off endeavor, but it requires active participation. If you don’t actively check in on your accounts and make sure you are on track for retirement, you could wind up overlooking small mistakes that can have real consequences.
One of the most common examples that people make when managing their own 401k accounts is they fail to reinvest dividends. As a result, money often piles up in their account instead of accumulating more shares over time. If you have the opportunity to automatically reinvest dividends, that can increase the effects of compounding returns (where the money you earn makes money).
Leverage Other Types of Accounts
A 401k should make up one piece of your overall retirement account. It’s not the only place you should be allocating money. In addition to having a 401k or Roth 401k, you should also be leveraging traditional IRAs and/or Roth IRAs.
It’s also a good idea to have a long-term savings account on hand that you add money to periodically. Look for a high-yield savings account (HYSA) from an online-only bank or a money market account that can provide strong savings rates along with flexibility.
This is important for capitalizing on opportunities that can set you up for more success in retirement. For example, you may find an attractive rental property that you want to buy and then flip for profit. This requires having immediate access to capital. You don’t want to start tapping into retirement accounts early or you’ll wind up paying heavy fees and taxes.
Start a Side Hustle
If you are having trouble maxing out your 401k, consider starting a side hustle to cover some of your ordinary expenses. A side hustle or side gig is a type of job that produces extra income in addition to what you’re already earning.
While you can’t contribute your side hustle earnings directly into your company 401k, you can use the money to pay for things like groceries, entertainment, auto expenses, or maybe even your mortgage or rental costs. This will allow you to save extra money from your day job and contribute that directly to your 401k.
Additionally, starting a side hustle can also teach you valuable skills that you may not learn in your full-time job.
Side hustles are extremely popular today, and it’s not uncommon for people to have four or five going at a time. The more you work, the more you make. Every dollar gets you an inch closer to financial freedom.
FAQ
We’ve compiled a list of our most frequent questions and answered them below.
Are 401ks tax-free?
You still have to pay taxes on the money you put into your 401k. However, you can do it on a tax-deferred basis. This is because 401ks leverage pre-tax dollars. Account holders pay taxes when they make withdrawals during retirement. This can be a tremendous benefit because it gives you more control over your money and the ability to grow it before you pay taxes to the IRS.
What is a 401k rollover?
A 401k rollover is a strategy that involves transferring money into a new plan or a different retirement account, like an IRA. Rollovers are typically done when transferring jobs or starting a new plan with a financial advisor or brokerage.
What type of return can I expect in my 401k?
Most 401ks generate an average return of between 5% to 8%, which is a little bit less than the stock market. This is because 401ks are typically conservative in nature and designed for long-term growth.
If you take control over your 401k and start investing on your own, you have the opportunity to buy and sell individual stocks that can potentially generate higher returns. Just remember that it’s incredibly difficult to time the market, and oftentimes people lose money trying to buy and sell stocks strategically.
Should I invest in a 401k before paying off student loans?
Only you can make this decision. However, it’s generally recommended to start saving for retirement as early as possible — especially if you have student loans that take years or decades to pay off.
Waiting until your student loans are paid off to save for retirement can prevent you from putting money aside during your prime earning years, meaning you’ll have to work twice as hard to save once your loans are paid in full.
If you are having trouble paying down student loans and putting money aside for retirement, you should use it as a motivating factor to work harder and earn more money. Keep rising and elevating yourself in your field and increase your salary to offset losses from student loan debt.
What are catch-up contributions?
As you get older, it becomes increasingly important to save for retirement. One of the best ways to maximize savings as you approach your retirement age is to leverage catch-up contributions. A catch-up contribution is a type of contribution that allows people who are 50 or over to make extra deposits to their 410ks and IRAs and exceed contribution limits.
The Bottom Line
A 401k is an excellent financial solution for investors of all ages. This type of investment plan can help create a strong financial plan and a solid financial future.
So talk to your employer about 401k options if you are not already doing so. And if you’ve been putting money into a 401k for years, consider looking into your portfolio to see if you’re saving enough for retirement and taking full advantage of all that the investment account has to offer.
Remember: Retirement is going to be here much faster than you anticipate. Unless you want to spend your golden years behind a cash register in a local pharmacy or driving for Uber while your friends are drinking martinis at the local country club, it’s in your best interest to start a savings plan and begin putting money aside so it can grow over time.
Best practices also call for working closely with a financial planner to help reduce income tax, maximize savings, and figure out how to put more money aside for retirement. Even if you think you are doing a good job, a financial planner can help you do more. This can be worth every penny — especially if you are bringing in a lot of money. At the end of the day, spending a little bit of money on financial planning can go a long way in helping you prepare for retirement.
No matter how much you’re putting into your 401k right now and what your balance is, take a deep breath and understand that you’re not retired just yet. You still have time to grow your account so that you can enjoy a comfortable financial future.
Getting there starts with developing a plan and sticking to it. With enough patience and determination, you’ll build a 401k you can be proud of in no time. Good luck!
Learn More:
How to Hack Your 401k Withdrawal Penalty
Roth 401k Might Make You Richer
What is an IRA?
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