Getting The Most Out Of Your 401(k)

When it comes to saving for retirement, signing up for your company’s 401(k) and contributing enough to get the employer match is a great first step. But it definitely shouldn’t be your last step. 

To have enough money in retirement, most of us will need to save a lot more than that. You can contribute up to $19,500 per year in your 401(k), and the pre-tax contribution is subtracted from your adjusted gross income. 

Retirement might feel really far away right now. But the more you can save early in your career — in your 401(k) and elsewhere — the more time that money has to grow before you start to need it. 

Always Get Your Employer Match

Lots of employers offer 401(k) or 403(b) matching to encourage their employees to start saving for retirement. This is usually expressed as a percentage — for example, the company will match up to 4% of your salary, or 50% of your salary up to 6%. 

In the first example, if you put 5% from every paycheck into your 401(k), your company will put the same amount of money into the account on your behalf. In the second, if you put 6% from each paycheck into your 401(k), the company will contribute an additional 3% of your salary on your behalf. (Bankrate has a great calculator that can help you visualize this.) 

If you can afford to have enough withheld from your paycheck to get the full match, sign up right now. You should always contribute enough to your 401(k) or 403(b) to get the match. It’s free money!

But it’s important to think about how much money this actually is. If your salary is $100,000 per year and you save 5% in your 401(k), that’s $5,000 per year. With a full match, it’s $10,000 per year. That’s better than nothing, and there’s no magic number that will tell you how much you need to save for retirement — but depending on your goals, you should probably try to put aside 15% or 20% of your income.   

So, yes, start saving for retirement by contributing enough to your 401(k) to get your employer’s match. But going forward, try to treat that as your minimum contribution to your retirement. 

If you have a 403(b) through your employer, note that these accounts are really similar to 401(k)s. Basically, 401(k)s are for employees at private companies and 403(b)s are for employees at nonprofits and government agencies. Most of these principles should apply to both types of accounts, but double-check with your human resources department if you have questions. 

You Can Save A Lot More Than That

Before you start putting more money into your 401(k) every month, beyond your employer match, think about whether a Roth IRA might be a better fit for you right now.

There are two key differences between 401(k)s and Roth IRAs: Who can contribute and how they’re taxed. 

Anyone can contribute to a 401(k) regardless of income. But you can only contribute to a Roth IRA in 2021 if your Modified Adjusted Gross Income (MAGI) is less than $140,000 as an individual or $208,000 as a married couple. Once your MAGI exceeds $125,000 as an individual or $198,000 as a married couple, you can still contribute to a Roth IRA, but at a reduced amount.

Generally, 401(k) contributions are made pre-tax, which means they come out of your paycheck before your taxes do. You’ll have to pay taxes on distributions in retirement, but not right now. Roth IRAs, on the other hand, are funded with after-tax dollars, so you don’t have to pay taxes on distributions in retirement.

There may be a Roth option in your 401(k), but it’s usually more advantageous to make a pre-tax contribution and lower your taxable income. 

If you’re early in your career and expect to earn more money later, then once you contribute enough to your 401(k) to get the full company match, it might make more sense to contribute to a Roth IRA before adding more to your 401(k). It’s a good idea to have multiple buckets to pull from in retirement. Plus, hacking your Roth IRA can help you work toward other financial goals.

You can contribute a maximum of $6,000 per year to a Roth IRA if you’re under age 50.

Maxing Out Your 401(k)

Once you’ve fully funded your Roth IRA or if your income already exceeds Roth IRA limits, then you can contribute a lot more to your 401(k). For 2021, the IRS caps 401(k) contributions at $19,500 per year, not including employer contributions.

If your company offers a match — say 5% of your salary — then you’ll still get the match on that amount. Whatever you contribute on top of that won’t be matched, but it will go into the same account and be invested in the funds you’ve picked.

Remember, every dollar you contribute to the pre-tax portion of your 401(k) will lower your adjusted gross income on your taxes. If you earned $150,000 last year and contributed the full $19,500 to your 401(k), your AGI would be $130,500 before any other deductions. 

Is That Enough For Retirement?

If you were to max out your 401(k), you’d be saving $19,500 per year for retirement, plus any contribution your company makes.

It’s important to remember that $19,500 is just where the IRS draws the line at giving you a tax break on contributions to your retirement accounts. It’s not a recommendation for how much you should be saving for retirement. 

If your household is earning $100,000 per year, then by maxing out your 401(k), you’re saving almost 20% of your income for retirement. That’s great! But if your income increases in the future or you want to save more aggressively, opening a taxable brokerage account can allow you to save and invest even more.

By making small, regular contributions to your retirement plan, you’re dollar cost averaging into the market. Buying shares at different price points over time generally means you pay less for those shares than you would if you tried to time the market.

How much do you really need for retirement? There’s no magic formula for figuring that out (although NerdWallet’s retirement calculator can help you wrap your head around it). How much you need for retirement depends a lot of factors — on your family situation, where you live, what you want the rest of your career to look like, what you want to do when you retire, and more. Working with a financial planner can help you figure out what that looks like for you and how much you’ll need to save to get there. 

And remember that saving for retirement doesn’t mean you can’t have fun now! Unless you’re pursuing an aggressive plan for early retirement, you should be able to create a spending plan that adequately funds your retirement while setting money aside for travel, hobbies, and kids’ needs. 

The key is to keep your priorities balanced. It can be tempting to save a little less for retirement now so you can spend more money on a bigger house or a nicer car. But the money in your retirement accounts is invested in the markets, and investment returns build on each other. The more you can invest sooner, the more time your money has to do its thing and the more flexibility you’ll have later. Your future self will thank you!