There are two sets of answers when it comes to the question of “how much should I put in my 401k?”
The first answer is the technical side – as in, how much are you actually allowed to put in your 401k each year? As you’ll soon see, the IRS caps how much you can put in your 401k each year.
The other answer is more qualitative and much more personal. If you’re unable to contribute the maximum amount, then how much should you contribute? Or better yet, should you contribute to your 401k at all?
This blog is about 401ks, but the rules we’re about to discuss also apply, for the most part, to other types of employer retirement plans like 403bs and TSPs. For simplicity’s sake we will use the term 401k as a catch-all since it is the most popular type of employer retirement account.
How much CAN you put in a 401k?
Employees / Individuals
As of this writing (2021), the most an employee can contribute to their 401k is $19,500. The IRS typically increases this amount by a little bit each year.
Contributions to 401ks are typically made via payroll deductions (also called “deferrals”). In other words, you tell your employer what percent (or dollar amount) of your paycheck you want to go into your 401k. For example, a 5% 401k deferral on a $2,000 paycheck would mean each pay period $100 goes into your 401k.
Those over age 50 are allowed to contribute even more to their 401ks. Currently the IRS allows those 50 and up to contribute an extra $6,500 per year – bringing their total allowable 401k contribution to $26,000 max. This is called a “catch up” contribution – in other words, the IRS permits those (presumably) closer to retirement age to “catch up” on their retirement savings.
As a job perk many employers offer to make contributions to their employees’ 401k account on top of what the employee contributes from their pay. An employer contribution may be in the form of a flat dollar amount, a flat percentage amount of the employee’s wages, or a matching percentage based on what the employee contributes. As of 2019, a 50% match up to 6% of pay was the most popular type of matching contribution. In this case, to be eligible for the full matching contribution, you’d need to contribute at least 6% of your pay into your 401k. Your employer would then chip in another 3% worth of your pay (i.e. 50% x 6%) as a matching contribution. Another common type of employer match is 100% (i.e. dollar-for-dollar) up to 3%. In short, an employer match is quite literally free money.
How much your employer can contribute to your 401k is based on how much you yourself contribute. At most, only $58,000 per year (as of 2021), not including catch up contributions, can be contributed to your 401k across all sources – i.e. between employee and employer contributions. So if you contribute the max of $19,500, that means at most your employer can only contribute $38,500 [$58,000 – $19,500]. If you contribute $10,000 then your employer can contribute $48,000 at most.
what if I have a side hustle?
Most people don’t realize that if they have a side hustle – such as freelancing, delivering Amazon packages, or being an Uber or Lyft driver, for example – they can set up their own retirement plan to stash away some or maybe all of that income. This side hustle retirement account could even be in addition to your day job 401k.
Popular options include SEP IRAs, SIMPLE IRAs, and Solo 401ks (also called Individual 401ks). There is no one-size-fits-all solution to which of these plans work best. Generally speaking, which plan you should choose depends on how much income your side hustle generates, how the business is structured (sole proprietor, LLC, S Corp, etc.), and whether you have any employees. Check out this graphic to learn more about SEPs, SIMPLEs, and other small business retirement plan options.
How much SHOULD you put in your 401k?
In general, if you can afford to defer the maximum amount in your 401k then it almost always makes sense to do so.
But not everyone can afford to put that much in their 401k. In this case, there are a few considerations for how much you should put in your 401k.
If your employer offers a matching contribution, you should try to contribute at least as much as their match. For example, if your employee offers to match your 401k contributions dollar-for-dollar up to 3%, then you should contribute at least 3% of your wages to 401k. If you only defer 1% then your employer will only give you a 1% match.
Not taking full advantage of an employer 401k match is like leaving free money on the table and giving yourself a pay decrease at the same time.
Your tax bracket
Every dollar put into your 401k is one less dollar taxed on your paycheck. Those in the highest tax bracket (37% as of 2021) have the most to gain (and the most to lose) from their 401k contributions. At a 37% tax bracket, $19,500 of wages deferred into a 401k saves over $7,200 in taxes [$19,500 x 37%]. Conversely, every dollar not put in a 401k costs an extra 37 cents in taxes.
In general the earlier you start saving, the better. For someone in their 20s just starting their career, time is the greatest asset at their disposal. While the default should be to at least contribute what your company will match, if that’s not possible you should at least consider contributing something – even as small as 1% of your wages – to take advantage of the power of compounding returns. Something is better than nothing.
Those nearing retirement may take a different approach. Those within 10 years of retirement should meet with a financial planner to determine if they are on the right course. In general, you want to leave yourself enough time to course-correct should your retirement goal not be on track.
If you are still working by your early 70s, you might consider putting only enough in your 401k to get the full company match, and then saving the rest in either a Roth IRA or non-retirement brokerage account. Why? Under current law, at age 72 individuals must start taking Required Minimum Distributions (‘RMDs’) from pre-tax retirement accounts such as 401ks. In other words, if you’re still working at 70 it might not make sense to max out your 401(k) only to have to turn around and take some of it out by age 72. It might make more sense to forego the upfront tax write-off in order to save yourself from larger RMDs in the near future.
If you are strapped with high interest debt such as student loans or credit cards, it might make more sense to focus on paying off the debt instead of fully funding a 401k account. Consider contributing at least enough to get the full company match, and then diverting the rest of your cash flow into a strategic debt payoff plan such as the debt snowball or debt avalanche.
The Bottom Line
The answer to how much you should put in your 401k is different for everyone. In most cases, if you can afford to put in the max ($19,500 in 2021) then by all means you should do so.
If you cannot afford to save the maximum, look at factors such as your employer match, age, and debt situation to determine what the right amount is. In almost all cases you should plan to at least put in as much as your company matches.
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