Ten percent? Twenty percent? More?
But everybody’s next question is: “Okay, okay, but how much should I put into my 401k?”
Comparing Without Competing
One of the most popular posts in this blog’s six-year archives is “How Much Should Be In Your 401k At 30?”
I was 25 when I wrote it, trying to decide how much to contribute to my own 401k.
But what I learned from over 200 (sometimes nasty) comments is that setting a savings benchmark by age alone is silly; no two savers are the same. You can’t compare the engineer who graduated at 22 into a $65,000-a-year job with no student loan debt to a doctor who starts practicing at 29 and has $200,000 in loans. Or the social worker earning $35,000 a year and needing all of it just to eat.
Today I want to provide slightly more tactical advice. As a percentage of your income, how much should you contribute to your 401(k)?
- If you’re in debt?
- If you can also do a Roth IRA?
- If your employer does not match funds?
A Few Rules
Here’s where to start:
- If your employer matches 401(k) funds, contribute enough to get the full match. Do this first. Even if you’re in debt. Even if you don’t put in a penny more.
- Next, if you can contribute to a Roth IRA, work on contributing the full $5,500 a year to that account before you contribute elsewhere.
There are lots of ratios out there recommending how to divide up your income. Some are as simple as spend 50 percent, save 50 percent. Although an admirable goal, most people will have a hard time with this. Especially in your twenties. I like 75/20/5.
- Spend 75 percent
- Save 20 percent
- Give 5 percent
But figure out the ratio you’re comfortable with. You may want to defer charitable giving until you’re debt-free. If you need most of your income to eat, it might be spend 90 save 10 or even 95/5. That’s okay. But you should reevaluate this as your financial situation changes and aim to get to at least 80/20.
In this example (75/20/5), if you earn $40,000, you would spend $30,000 or $2,500 a month, save $8,000 a year, or $667 a month, and — if you want — set aside $2,000 a year for your chosen causes. Note that we’re working off of before-tax income, so that $2,500 a month for spending might be more like $2,000 after taxes).
Working backwards from this, let’s say your employer will match a 6-percent contribution to your 401k. So 6 percent of your pre-tax income is $3,000. You put that in, and you have $5,000 left in your savings budget.
If you don’t have a fully-funded emergency fund, this comes next.
If you have plenty for a rainy day, then you return to your retirement options. If you qualify for a Roth IRA, then that’s probably where the $5,000 should go. If you don’t qualify or have more than $5,000 left to spend, return to your 401(k) and up your contributions.
The lesson is: Figure out what percentage of your income you can save in total, and allocate it appropriately:
- 401(k) up to employer match cap.
- Emergency savings until you have six months’ living expenses.
- Roth IRA up to $5,500 annual cap.
- Back to your 401(k).
This flowchart from my post on creating an automated investing program will also help:
What If You’re In Debt?
If your employer matches 401(k) contributions, put in enough to get that match, even if you’re in debt.
Next, if you’re in credit card debt, stop. Put your extra money towards paying that off before making additional retirement contributions.
Got student loans? Follow the above schedule anyway. Unless your private loans have double-digit interest rates, I don’t recommend repaying student loans early.
- The $1 Million 401(k): Investing strategy for 20- and 30-somethings
- How much should be in your 401(k) at 30?
What About You?
How much — as a percentage of your gross income — do you put aside for retirement? Let us know in a comment.