One of the most common investment vehicles, a 401k is a tax-advantaged, employer-sponsored retirement plan. Some employers will even match a portion of your contributions. For these reasons, a 401k can be extremely valuable in meeting your long-term retirement goals.
In a recent Personal Capital survey, only about 50% of people reported currently contributing to their 401k every paycheck. Even less people — around 49% — said they receive the maximum match from their employer.
If you are contributing to a 401k, are you saving enough? Let’s find out.
Calculate How Your 401k Savings Compare
Use this calculator to see how your 401k balance compares to others in your age group.
Key Investment Terms & Definitions
To help you better understand your 401k, following is a handful of common 401k investing terms and definitions.
- Current 401k balance: The amount you currently have invested or saved in your 401k.
- Annual salary: Your yearly income before taxes and other benefit deductions.
- Percent to contribute: The percentage of your annual salary that you put toward your 401k each year.
- Annual contribution limits: Your total contribution for one year is based on your annual salary times the percent you contribute. Note that your annual contribution is also subject to certain contribution limits set by the IRS. The annual maximum is $19,500 for 2021 and $20,500 for 2022. Starting at age 50, a “catch-up” contribution allows you to put aside an additional $6,000 every year. Employer contributions do not go toward an employee’s maximum annual contribution limit.
Benefits of a 401k
Contributing to a 401k as soon as possible can be a small act with significant impact. Consider this analysis of the average 401k balances by age, which shows the long-term payoff of compound interest and disciplined 401k contributions.
Traditional 401k plans are tax-deferred. This means that you don’t have to pay income taxes on your contributions. When you retire, all withdrawals you make are treated as regular income: you pay income tax according to your income tax bracket for that year.
Your employer may match your 401k contributions on a percentage basis. This is the same thing as a guaranteed, no-risk return on your investment.
Employer-Sponsored 401k Plans
For most employees, a defined contribution plan like a 401k is one of the primary benefits offered by their employer. Employer matching of your 401k contributions means that your employer contributes a certain amount to your retirement savings plan based on the amount of your annual contribution.
Specific terms of 401k matching can vary widely. Your employer may use a very generous matching formula, or choose not to match your contributions at all. Additionally, not all employer contributions to an employee’s 401k plan are the result of matching. Employers may make regular deferrals to employee plans regardless of employee contributions, though this is not particularly common.
Make sure you check your employer’s plan documents for the details on exactly how your 401k works.
Leaving your job is another time to consider your 401k. During this big life transition, you may want to consider a 401k rollover. This could help you avoid higher fees and get more investing options.
Types of Investments in a 401k
A company’s 401k typically offers employees several investment options. Employees can choose one or several funds to invest in. Most of the options are mutual funds.
Other options may include index funds, large-cap and small-cap funds, foreign funds, real estate funds, and bond funds.
They usually range from conservative income funds to aggressive growth funds.
How Much of Your Salary Should Go into Your 401k?
A common answer is “as much as you can contribute.” Instead of aiming for a numerical amount, instead consider a percentage of your salary. This way, your contributions will increase in line with your salary. Numerous financial planning studies indicate the ideal contribution percentage to save for retirement is between 15% and 20% of your gross income. You can put these funds into your 401k, Roth IRA, or other tax-advantaged retirement accounts.
If your employer offers 401k matching, consider at least contributing enough to get the full employer match. Otherwise, you’re leaving part of your overall compensation on the table.
Making the Most of Your 401k
If you’re falling short with your current savings, don’t fret. It’s not too late to get on track.
Here are a few avenues for making improvements to your retirement plan.
- Maximize your savings rate by contributing as much as you can afford (and as much as is allowed by law). There is a compounding effect to investing. As your assets appreciate over time, all future gains are based on that larger base. The longer you can take advantage of that compounding effect, the better.
- Contribute at least as much as is required to receive your employer match. If you don’t, it’s like ripping up a paycheck. That match is part of your compensation as an employee – don’t refuse it.
- Avoid taking early withdraws. Try to think of your retirement savings accounts like a pension. People working towards a pension tend to forget about it until they retire. While that money is locked up until later in life, it becomes a hugely powerful resource in retirement.
- Be honest with yourself about how much time you want to devote to learning about your 401k and organizing your financial goals. If you know you won’t spend enough time on your own 401k management, get to know a financial advisor who can help you with your 401k. You want to make sure you’re on track to meet your goals, and one of the best ways to do that is to have someone with experience show you the way. Personal Capital is able to directly manage investment clients’ 401k, 403b, and 457 plan accounts, as well as PSP and TSP account types. Just like with taxable and IRA accounts, clients can track all transactions on their Personal Capital Dashboard.
Next Steps for You
Regardless of how you compare to your peers, you can make progress by staying on top of your retirement plan. Consider using free online finance tools like Personal Capital’s Retirement Planner to track your progress towards your own retirement goals.