No, there is no minimum you have to contribute to your traditional 401(k) plan. To maximize your retirement account potential, on the other hand, there are suggested amounts that should be contributed. There is also a maximum that you are allowed to contribute to your account. That maximum is based on certain criteria.
- There is no minimum amount that you must contribute to a 401(k) plan.
- There are maximum yearly amounts mandated by law.
- Contributions to a traditional 401(k) plan are pre-tax, which reduces your taxes for the year in which they are made.
Suggested 401(k) Contributions
Let’s focus on the suggested amounts first. According to Forbes, some experts state you should have a sum equal to the amount of your yearly income socked away in a 401(k) by the time you are 35. Ten years later, when you turn 45, you should have three times your annual income saved. For example, if you make $50,000 a year at 35, you should have $50,000 saved by then and $150,000 saved by 45.
Other personal finance pros advise that workers should invest between 6% and 10% of their monthly income. If you make $2,000 a month, you should save between $120 and $200 monthly. For many people, this is more realistic and doable. As a general rule, saving a little is better than saving nothing at all, but you should strive to save as much as you can while still meeting your daily financial obligations.
Maximum Contributions Allowed
If you have the income to save substantially, there are maximum contributions you will need to consider. Workers under the age of 50 can save up to $19,500 in 2020 and $19,500 in 2021. If you are age 50 or over, you can invest an additional $6,500 in catch-up payments, for a total of $26,000 in 2020 and 2021. This equates to about $1,625 a month for those under 50 and $2,167 per month for those 50 and over. (There is no age limit on contributing, by the way. As long as you are still employed by the company that sponsors the 401(k), you may participate in the plan.)
If your employer offers pre- and post-tax options, there can be two choices for saving in a 401(k), with implications for your taxes now and for what you'll owe after you retire when you start taking money out of your 401(k).
Option 1: Saving With Pre-Tax Dollars
There are definite advantages to saving as much as possible in a traditional 401(k). One is that by investing the funds, you will have a lower tax burden at the end of the year, as 401(k) contributions are made with pre-tax dollars. This means the amount you invest in the plan effectively reduces your gross income. Less income to be taxed decreases the amount of taxes you owe.
However, it is important to remember that your 401(k) funds will be taxed when you withdraw them, so you might want to keep that in mind when determining how much you want to invest. If you expect to be in a lower tax bracket after retirement than you were before, a traditional 401(k) is likely the way to go. There is, however, another alternative, if your employer offers it.
Contributions to a Roth 401(k) are taxed at the time they are made, which means that subsequent earnings and withdrawals will not be taxed.
Option 2: Saving With Post-Tax Dollars
A Roth 401(k) operates a bit differently than a traditional 401(k) fund, and not all employers offer it, though if they do, they must also offer a traditional 401(k) plan. Instead of your investment dollars going into the fund before taxation, they are invested after being taxed, which means no reduction of your gross income when you contribute. This might mean you have less money you can afford to invest.
The good news is that when it’s time to start withdrawing and living off of the funds, all the money in the account is yours—no tax is due on it as you already paid it when you invested. That applies to any earnings amassed by the account as well (assuming you’re retired and above a certain age). So if you expect to be in a higher tax bracket after retirement than you were before, a Roth 401(k) is probably a good idea.
Required Minimum Distributions and Early Withdrawal Penalties
With both a traditional and a Roth 401(k), there is a 10% penalty if funds are withdrawn before you turn 59½. And once you turn 72, you must start taking the required minimum distributions. There are some strategies and exceptions to these rules, but in most cases, you will have to follow them.
The Bottom Line
While there is no minimum amount you must invest in a 401(k), there are maximum amounts above which you cannot go. And because 401(k) contributions are made with pre-tax dollars, the amounts you contribute will reduce your gross income, which in turn will reduce your taxes.
You may also have the option to set up a Roth 401(k), whose contributions are taxed at the time they are made. The benefit of that is that your subsequent withdrawals during retirement will not be taxed, and neither will the earnings made by those funds while in the Roth 401(k).
Remember, whichever approach you choose, pre-tax or post-tax, investing in your retirement is always a good thing.