If you’re wondering how much you should put in your 401(k), one good rule of thumb is 15% of your pretax income, including your employer’s match. But that’s just a general rule.
We’ll assume in this article that your 401(k) withdrawals will be your only income source in retirement, but the actual amount you need to save in your 401(k) plan depends on a number of factors, including:
- Your additional sources of income in retirement, such as a pension or rental income
- Your other retirement savings, including traditional or Roth IRAs
- Your Social Security-claiming plans
- How long you plan to work
- How many years you expect to spend in retirement
- The earlier you start saving for retirement, the less you’ll need to save each month.
- While 15% of your pre-retirement income is a good ballpark estimate for how much you should save, the actual amount depends on your circumstances.
- When you stop working, aim to replace about 80% of pre-retirement earnings with all post-retirement income sources combined.
The Power of Compound Returns
The earlier you start saving for retirement, the less you’ll need to save each month. You can thank compounding, which is basically the returns you make on returns. Once you’re making money on your earnings, your returns compound at an accelerated rate.
Suppose you want to retire at age 60 with $2 million and that you get average returns of 10%. That’s slightly less than what the S&P 500 index has delivered before inflation over the past 60 years with dividends reinvested.
Here’s what you’d need to invest, between your own contributions and your employer’s match, if you have a $50,000 annual salary.
- If you started investing at 20: You’d need to invest $316.25 per month, or 7.6% of your salary.
- If you started investing at 30: You’d need to invest $884.76 per month, or 21.2% of your salary.
- If you started investing at 40: You’d need to invest $2,633.76 per month, or 63.2% of your salary.
The examples above show not only how much more you’ll have to contribute to your 401(k) each month if you start saving later, but also how much more you’ll have to save overall. In the first example, you’d invest just under $152,000 total by starting at 20. But if you didn’t get started until 40, you’d wind up investing more than $632,000 to reach your goal.
Keep in mind that 10% is an average, not the 401(k) rate of return you should expect every year. Your returns will vary, based on how your investments perform, along with the risk tolerance you indicate when you choose your investments.
As you get closer to retirement, you’ll want to take less risk, which lowers your expected average annual returns.
Your 401(k) Investing Rules of Thumb
These 401(k) investing rules of thumb won’t apply to everyone, but they’re a good starting point for retirement planning.
Take Advantage of Your Employer’s Match
If you get an employer matching 401(k) contribution, always take advantage, unless you wouldn’t otherwise be able to pay your bills.
Plan to Replace About 80% of Income
When you stop working, aim to replace about 80% of pre-retirement earnings from all income sources combined, such as 401(k)s and IRAs, Social Security, and pensions.
You can anticipate spending less, because you’ll no longer be paying payroll taxes or making 401(k) contributions. You may also spend less on things like gas and clothing, because you’re no longer working. The actual amount you’ll need in order to replace your working income depends on how frugal or luxurious you want your retirement to be.
The 4% and 25x Rules
According to the popular 4% rule, your risk of outliving your retirement savings over 30 years drops if you limit your withdrawals to 4% of your account balance each year in retirement. You slightly adjust the dollar amount you withdraw each year to account for inflation. Using the same rule, you’d want 25 times the amount of income you wish to withdraw annually saved by the time you retire. You can adjust your 401(k) contributions over time based on this goal.
How to Calculate Your Monthly 401(k) Contribution
In both 2020 and 2021, the 401(k) contribution limit has been $19,500 for those under age 50. Workers age 50 or older can make an additional catch-up contribution of $6,500. You and your employer’s combined contributions can’t exceed $57,000 in 2020 or $58,000 in 2021, excluding catch-up contributions.
However, few people actually contribute these amounts. Only 12% of plan participants made the maximum contribution in 2019, when the limit was $19,000, according to Vanguard's 2020 “How America Saves” report.
To determine how much you should be saving, you can use Social Security’s retirement estimator and see what monthly benefit you can expect from that fund. You also can use a retirement calculator to estimate how much you’ll need each month on top of Social Security. Choose a calculator that allows you to personalize as many factors as possible, including your current age and account balance, anticipated contributions, other sources of income, and expected rates of return.
Choosing Health Insurance, Bills, or Your 401(k)
If you can’t afford to pay your monthly bills, you can’t afford to make 401(k) contributions. If there are unexpected expenses or loss of income, you may even need to withdraw retirement money early. If possible, focus on putting in the minimum to get your employer’s match, then use additional money to pay off any high-interest debt, like credit cards.
One option, if you’re struggling to afford your 401(k) contributions, is to choose a cheaper health insurance plan. People who overpay for health insurance are 23% more likely to forgo their employer’s retirement match, a TIAA Institute study found.
A health savings account (HSA) can help you reduce health costs and save for retirement at the same time. You can only fund one if you have a high-deductible health plan, which often leads to higher out-of-pocket costs. You fund an HSA with pretax money. When you spend it on Internal Revenue Service (IRS)-approved qualified medical expenses, your distributions for those are also tax-free and penalty-free.
An HSA is a good supplement to your 401(k) contributions, because if you have unused money in the account when you turn 65, you can withdraw it without penalty for any purpose, though you’ll owe income taxes for distributions made for non-qualified medical expenses.
The Bottom Line
While 15% of your pre-retirement income is a good ballpark estimate for how much you should save, the actual amount depends on your circumstances. The earlier you start contributing to your 401(k), the less you’ll need to contribute each month and overall. Always try to contribute enough to get your employer’s full match if that’s available. Otherwise, you’re giving up free money.