How Much Money Should You Put In Your 401K

How much to save to a retirement account is a question that plagues many people.  Balancing the short term desire to take home the most cash you can with the long term need for savings and financial security is a classic human conundrum similar to eating a big tasty meal tonight vs the long term desire to be fit and healthy.  How does one weigh the present against the future?  How much do you really need to live comfortably in retirement?  How do you reach that number once you know?

While we can’t predict the future, we can help you plan responsibly in a way that doesn’t take too much money out of your current paycheck.  Read on to learn how much of your income you should allocate to your 401(k), IRA, or other retirement account.

Calculator

To start, here is a simple calculator to show you about how much you will need to save every single month in order to maintain your lifestyle during retirement.  Surprised by how high your number is?  Remember just how much it really takes to live and how quickly costs have been increasing.  This does not take social security into account because, well let’s be honest you may not receive any social security if your under 50 years old.  Many people also receive a matching contribution from their employers and this number is a total.  If your employer has a match then this number will be reduced by the amount of the matching contribution. Remember your individual situation may be significantly more complex so this is just a good estimation of how much you need to put away.  Read on below to figure out how to do a thorough analysis.

Put Away Up to the Maximum Possible Match

If you are not at least putting away the maximum amount of money in your 401(k) that your employer is willing to provide a matching contribution for then you are wasting a golden opportunity for free money.  Taking advantage of matching contributions from an employer is like giving yourself a raise.  Your income goes up by the amount of the match.

A common misconception is that if you put away what your employer is willing to match (often 2% or 3%) then you will have enough money in retirement to live comfortably.  Keep in mind that for most people, this is not the case and that you very well may need to put away significantly more than this.  Many experts recommend saving a total of 10% to 15% of your income for your entire life.  When the cost of living is rising significantly, like it is right now for many people, it become especially evident that you need to put away a lot of money to live comfortably into retirement.  People who depend upon Social Security for their retirement may find themselves sorely disappointed in their quality of life once they reach that age.  You are much better off saving the money yourself, investing wisely, and knowing that you have the freedom to choose your own path in retirement.

Factors Affecting How Much You Need to Save

Here is a list of factors that will affect the total amount of money that you need to save:

  • Current Age
  • Retirement Age
  • Current Savings
  • Current Income
  • Expected Rate of Return
  • Current Debt
  • When Debt will be retired
  • Will you have a Mortgage in retirement?
  • Value of Assets to be sold before retirement (i.e. a business)
  • Expected Life
  • Expected Life of Spouse or Dependent
  • Expected Inflation Rate
  • Expected Social Security
  • Other Retirement Income

What You Are Trying To Solve For

Basically what you are trying to solve for is, if you didn’t save another dollar, how much would your shortfall be in total during retirement?  Your shortfall defined by the total amount of money you need to live during retirement minus the future value of the current amount of money you have.

A simple way to look at this is, if you spend $2,000 a month and plan on retiring at age 70 and continuing to spend the same amount, you will probably need to plan for 30 years of spending.  30 years times 12 months a year times $2,000 equals $720,000.  If your compound interest keeps pace with the rate of inflation, you basically need to come up with $720,000 between now and when you retire.

If you are 35 years old and have 35 years until you retire, you need to save $720,000 divided by 35 years times 12 months a year equals $1,714 a month!  Realistically speaking, if you are investing properly, you should realize a rate of return on your investments great than the rate of inflation.  These numbers can be sobering though when you realize just how much money you need to put away just to make ends meet in retirement.

So How Much Should You Really Save- 10% Rule

The truth is you should save as much as you possibly can spare.  Social security may not be around in a couple of decades, inflation will keep devaluing cash, and you can’t count on earning a huge rate of return.  The best realistic policy is to put away 10% of your income regardless of the match your employer gives to you.  If you get a 4% match, then great you will be saving 14% of your income annually.  If you don’t get a match, you will still be saving a decent portion.

If you save 10% every year, and allocate your investment wisely, you should end up with a relatively comfortable cushion on which to retire.  Yes, if you want to try to beat the stock market you can invest your 401(k) in gold.  The key to any successful retirement savings is to be consistent in putting away money and keeping it invested during all market cycles, as long as you are allocated well.

Don’t underestimate how important it is to allocate your 401(k) or IRA properly.  If you don’t have the right investing plan in place to weather the storms and still take part in the upswings in the market, you will be severely disappointed with how much money you end up with at retirement.  Allocation is equally as important as how much you save because of the power of compound interest.  A difference of 2% a year can double or halve your total account over 40 years.

After Tax It Does Not Hurt As Bad

Most people have about 30%-35% of their pay taken from their check between federal and state taxes.  This means that the true after tax cost of putting away pre-tax dollars is not really so bad.  If you pay 35% of your income to tax and you are saving 10% to your 401(k), your post tax income is only reduced 6.5%!

Reducing your take home pay by 6.5% is noticeable, but it shouldn’t really affect your ability to maintain your lifestyle.  If it does, your lifestyle is probably not appropriate for the amount of money that you make.  Consider making changes and restructuring your life so that you can meet this goal.  With some steady saving and patience, you will be ready for retirement.