Roger Wohlner is a writer and financial advisor with over 20 years of financial services experience. He writes about financial planning for Wealthsimple and for a number of financial advisors. His work has been published in Investopedia, Yahoo! Finance, The Motley Fool, Money.com, US News among other publications. Roger owns his own finance blog called 'The Chicago Financial Planner'. He holds an MBA from Marquette University and a Bachelor’s degree with an emphasis on finance from the University of Wisconsin-Oshkosh.
The question of how much to contribute to your employer retirement plan, whether a 401(k) or some other version, is one that is often asked. We all have other financial priorities and that money can go toward those priorities.
The simple answer is: as much as you can, up to the plan’s limits. The more complicated answer is not really an answer at all: You have to view your contribution in the context of your entire financial plan and your overall situation.
How much to contribute to my 401(k)
The easy answer to this question is “the more the better” because the biggest determinant of how much you will have accumulated for retirement is in large part predicated on the amount that you’ve saved while working.
The benefits of compounding
One of the major benefits of the 401(k) is the benefit of tax-deferred growth for your investments in the plan. No taxes are due on the money contributed to the plan or the growth on investments until the money is withdrawn, presumably in retirement.
The principal of compounding is another important principal to keep in mind.
A chart published in 1994 by USAA sums it up nicely for an investor saving $250 per month and earning an 8% return:
If you start saving at age 25, you’ll accumulate $878,570 by age 65.
If you start saving at age 35, you’ll accumulate $375,073 by age 65.
If you start saving at age 45, you’ll accumulate $148,236 by age 65.
While there are many versions and variations of this out there, the message is both simple and clear. Start investing in your 401(k) or RRSP as soon as you can and save as much as you can. While the investments you choose and the performance of those investments matter, the truth is that time and diligence in saving for retirement will go a long way in determining how much you actually accumulate for retirement.
How much should I have saved at my age?
Both T. Rowe Price and Fidelity have done some excellent research on the topic of how much of your current salary you should have saved for retirement by a particular age. Their findings are similar but a little different.
According to T. Rowe Price, you should have these multiples of your salary saved:
At age 30 you should have 0.5 times your salary saved for retirement. For someone earning $60,000 this would equate to $30,000 saved for retirement.
At age 35 they suggest 1 time your salary.
At age 40 they suggest 2 times your current salary.
At age 45 they suggest 3 times your salary.
At age 50 they suggest 5 times your salary.
At age 55 they suggest 7 times your salary.
At age 60 they suggest 9 times your salary.
At age 65 they suggest 11 times your salary. For someone earning $75,000 at the time, this would equate to $825,000 in retirement savings.
These guidelines are midpoints in a range that T. Rowe Price calculated in an extensive study. There overall suggestion is that most investors target saving 15% of their salary for retirement each year.
Fidelity’s suggested savings benchmarks are similar:
They suggest 1 time your salary by age 30.
They suggest 3 times your salary by age 40.
They suggest 6 times your salary by age 50.
They suggest 8 times your salary by age 60.
They suggest 10 times your salary by age 67.
These benchmarks, and those from any number of other studies and retirement calculators out there, are just that: benchmarks. They are a great starting point to provide a set of savings targets and goals. This is, however, just the beginning.
Look at your own situation
Benchmarks and guidelines are a great starting point for your retirement savings goals. Beyond that, you need to look at your own situation. What do your retirement goals look like? Ask yourself some questions like:
How long do I plan to work?
What type of lifestyle do I envision for my retirement?
Is self-employment in my future?
Whether you are married or single will factor into the equation. If you are married and your spouse works and has a retirement plan you essentially have two people saving toward retirement. While the expenses for two people are generally higher than for one person, they are often not twice as much as those for one person.
If you are nearing retirement, ask yourself: Where will you live? What activities will you engage in? Will you continue to work part-time or full-time?
For those who are younger and contemplating an earlier exit from the workforce, such as those who subscribe to the popular FIRE movement, your 401(k) can be a critically important component. Here again it behooves you to save as much as you can, but while also considering any issues you might have with taxes upon withdrawing from the account prior to age 59 ½.
Maximum contributions to 401(k)
For 2019, the maximum contribution that you can make as an employee is $19,000. For those who are 50 or over at any point during the year, an extra $6,000 catch-up contribution is available.
For those who are self-employed and save via a solo 401(k), the maximum employee contribution limits are the same $19,000/$25,000. These individuals can also make profit sharing contributions equal to 25% of their compensation up to a maximum of $56,000/$61,000.
Average 401(k) contributions
According to Vanguard’s How America Saves 2018 study, the average salary deferral rate in 2017 across workers of all ages and income levels was 6.8%, this was unchanged from the prior year. This reflects only the amount saved directly by the plan participant.
Vanguard’s study also looked the amount contributed by employers via profit sharing and/or matching contributions. When this is factored in, the average 15-year total contribution rate was 10.7% for 2017, the median rate was 9.7% of compensation. Vanguard indicates that these savings rates have remained fairly stable over the past 15 years.
A 401(k) plan can be a solid tool to save for your retirement. Consideration should be given to your goals, time-horizon and to other types of savings and investment you may have. Consideration should also be given to the quality of the investments offered within the plan as well as the overall cost to you as a participant. The key word is tool, use your 401(k) as a retirement savings tool in a way that best fits your needs.