The Ideal 401(k) Contribution

No matter your age, you probably have a lot of questions and concerns about saving for retirement. How to save for it, what options are available, and, most important, how much money should you be socking away?

One of the most common ways to start saving for retirement is through an employer-sponsored 401(k) plan. Many companies offer them, and for most people, this is their sole retirement savings account. But with so many options, unfamiliar terms, stipulations, and rules, 401(k)s can be mystifying even to some financially-literate savers. Here, we'll answer one of the more common questions.

Key Takeaways

  • Saving for retirement can be complicated—undersaving can leave you high and dry in retirement, but oversaving can leave you without day-to-day spending money.
  • Balancing your current and near-term consumption with long-term spending goals is key.
  • Take advantage of your employer's contribution match if one is offered and contribute at least enough to get the full match.
  • Be aware of the annual contribution limits that cap the total you can put into your 401(k).

Contribution Limits

First, it's important to know the Internal Revenue Service's (IRS) limits on contributions: The elective deferral (contribution) limit for employees who participate in a 401(k) (or in a 403(b), most 457 plans, and the federal government’s Thrift Savings Plan) is $19,500, up from $19,000 for 2019.

The catch-up contribution limit for employees age 50 and over who participate in any of the above-mentioned plans is $6,500 for 2020 (putting the total potential contribution at $26,000) and $6,000 for 2019 (or $25,000 total).

What's the Ideal Amount to Set Aside?

Of course, each person's answer to this question depends on individual retirement goals, existing resources, lifestyle, and family decisions, but a common notion is to set aside at least 10% of your gross earnings into a retirement fund as a start.

In any case, if your company offers a 401(k) match, you should contribute at least enough to get the full match—it's free money, after all. Many companies (though not all) offer a match, so be sure to check if your plan features one and contribute enough to get all of the match. You can always ramp up or scale back your deferral rate later.

“There is no ideal contribution to a 401(k) plan unless there is a company match. You should always take full advantage of a company match because it is essentially free money that the company gives you,” notes Arie Korving, a financial advisor with Korving & Company in Suffolk, Va.

Many plans require a 6% deferral to get the full match, and a lot of savers stop there. That may be enough for some, who may have other resources, but for most it probably won't be. If you start early enough, given the time your savings have to grow, even 10% may add up to a very nice nest egg—especially as your salary increases.

Take Note, Older Savers

If you start saving later in life, especially when you're in your 50s, you may need to increase your contribution amount. Luckily, late savers have an opportunity to catch up, which lets them contribute more annually than is usually allowed. As noted above, the limit on catch-up contributions is $6,000 for individuals who are age 50 or older—any day of that calendar year. If you turn 50 on or before Dec. 31, 2019, for example, you can contribute an additional $6,000 above the $19,000 401(k) contribution limit for the year for a total of $25,000.

“As far as an ‘ideal’ contribution is concerned, that depends on many variables,” said Dave Rowan, a financial advisor with Rowan Financial in Bethlehem, Pa. “Perhaps the biggest is your age. If you begin saving in your 20s, then 10% is generally sufficient to fund a decent retirement. However, if you're in your 50s and just getting started, you'll likely need to save more than that.”

The amount your employer matches does not count toward your annual salary deferral limit. 

The More the Better

There are indeed many variables to consider when thinking about that ideal amount for retirement. Are you married? Is your spouse employed? How much can you expect from Social Security benefits? Retirement age calls for a certain amount of comfort, but this also varies by lifestyle. Will you spend most of your time gardening at home, traveling, spending time with the grandkids, or perhaps riding a motorcycle cross-country? Will health concerns lead to big, unexpected bills? 

All of these factors should be taken into account when planning for retirement. However, regardless of your age and marital status, most financial advisors agree that 10–20% of your salary is a good amount to contribute toward your retirement fund. And for those who want to go even further, there are several options, such as traditional IRAs and Roth IRAs. (The 2019 limit on IRA contributions is $6,000, with a $1,000 catch-up contribution for those 50 or older.)

“The ideal contribution rate for retirement depends on a few different factors,” says Mark Hebner of Index Fund Advisors in Irvine, Calif., “but a good sweet spot is 10% to 15%—more towards 15% if you can afford to do so. The bare minimum is 10%.”

“If you can, you should move closer to a 20% contribution to your retirement plan and keep that amount as your salary increases,” suggests Nickolas Strain, a financial advisor with Halbert Hargrove in Long Beach, Calif. “Most financial planning studies suggest that the ideal contribution percentage to save for retirement is between 15% and 20% of gross income. These contributions could be made into a 401(k) plan, 401(k) match received from an employer, IRA, Roth IRA, and/or taxable accounts. As your income grows, it is important to continue to save 15% to 20% of it so that you can invest the funds and grow your investments until you need to start taking distributions in retirement.”

The Bottom Line

Planning for retirement—and doing it early—is really important. If done properly, and with some financial sacrifices, you can ensure a nice quality of life in retirement. The most important thing is to contribute as much as you can as early as you can and be sure to take full advantage of your employer’s matching contributions, if any.

Besides a 401(k), you may want to look into opening additional accounts, such as an IRA, a Roth IRA, or other vehicles or investments. If all of this financial planning seems overwhelming, it may be a good idea to look into a fee-only financial advisor for advice on how to proceed when your options, resources, and needs increase.