How Much Should I Put In My 401K?


How Much Should I Put In My 401K?

In general, you shouldn’t ever invest more than you can afford into your 401K. This money is meant to be kept in your retirement fund until after you retire (or at least 59 in most cases). There are instances where you can get to this money early, but they will generally include either taking a loan from yourself (and paying it back with interest), or paying a penalty and taxes on the money in order to withdraw the dollars early.

Why Put Money In At All Then?

401Ks are both Tax-Deductible and they grow Tax-Deferred. This means that you are able to write off the money that you put into your 401K. For example, if you make $100,000 a year and you put 15% away into your 401K, you would only pay taxes on $85,000. Basically, you would have put $15,000 into your retirement account, and you would have saved $4,200 (assuming you were in the 28% tax bracket). This $15,000 would then grow tax-deferred until you withdrew the money during retirement. If you never put another dollar into the 401K, that $15,000 would grow to over $100,000 if it grew at 10% a year over the next 20 years. At that point, you would have paid no taxes on the $85,000 of gains, and you would have saved $4,200 in taxes 20 years ago. Between those two benefits, you would have made a lot more money than if you had put $15,000 in a taxable non-retirement account, and you would not have had any tax benefit in that scenario. As you can imagine, if you put in 15% every year, you would save tens of thousands of dollars in taxes throughout the years, as well as benefitted from huge tax-deferred gains. You would have to pay taxes as you begin to withdraw these funds during retirement, but the common thought is that your tax bracket will be lower in retirement than it is while you are working. If you believe that will be true, and you can afford to invest the money, then you should almost certainly be investing in your 401K.

How Much Should I Put In?

The first thing to note here is that many companies offer a corporate match. Many of these matches will give you X% of the first Y% contribution. For example, they might offer you a 50% match on your first 6% contributions. This means that if you make $50,000 a year, and you put in zero dollars, your company will match zero dollars, giving you a zero percent return on your money. If you were to put in 6% ($3,000), the company will match you 3% ($1,500). Therefore, you will have $4,500 in 401K contributions for the year, and your immediate return was 50% on your money. If you were to put in 15% ($7,500), the company would still only match 3% ($1,500). Your immediate return is now only 20% on your money. The moral of this story is that if you do not invest up to the company’s matching percentage, then you are giving away free money. At which point you get up to the company’s matching percentage, you should consider all of the investment options available to you before you decide to continue investing much more into your 401K. I am not saying that investing 15% in your 401K is a bad idea (in general, it is not a bad idea at all), I am only saying that the minimum you should invest is enough to take advantage of the full company match, and after that you should investigate all of your options before deciding which vehicle to put the rest of your money into.

Retirement Junkie is a website that the Hagopian Institute put together as a source for free information to help people prepare for retirement.  Please visit retirementjunkie.com, and follow MrEmergingMedia on Twitter for more retirement tips, along with other fun offerings from Todd Hagopian and the Hagopian Institute.

Advertisements

About Todd Hagopian (@ToddHagopian)

Todd Hagopian received his BA from Eastern Michigan University with a major in Political Science. After graduation, he worked as a Financial Advisor and a Bank Manager before returning to school. He attended Michigan State University, where he completed an MBA with a double-major in Finance and Marketing. Todd is now a Senior Product Development Manager for a Fortune 500 company. He frequently writes about business issues, social media strategy, and political issues that he finds important. Enjoy the blog!

Posted on December 14, 2011, in Investing and tagged , , , , , , . Bookmark the permalink. Leave a comment.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: