Almost every financial advice source will tell you to save to your 401(k) to get the employer match. This is the matching contribution your employer makes to your retirement account for participating. Generally, employers offer a match up to a certain percentage; for example, a match dollar for dollar up to 3% of your salary and then $0.50 on the dollar for the next 2%. We’ve always said this is free money—and the only way to get a guaranteed return.
Surprisingly, it’s reported that a majority of people do not take full advantage of a match. When you give up that match, plus growth, and the compound interest it can earn over a number of years, that becomes a significant amount of money to give up. At $50,000, a 3% contribution is $1,500 a year, and if your employer is matching dollar-for-dollar up to 3% of your salary, that is another $1,500 a year. With a conservative 7% return, that $1,500 a year over a 30-year span adds up to approximately $225,000 with growth and compounding.
However, while getting the employer match is important, that should really be the bare minimum you save. And of course, that begs the question, how much should you be saving? When we work with 401(k) plan participants, we answer that question by asking, “How much do you want to spend in retirement?” A $1,000,000 account balance won’t last very long if you intend to spend $500,000 a year.
Most 401(k) platforms offer participants a calculator to show you how your contribution will affect your take-home pay. Because a traditional 401(k) contribution is pre-tax, it is not a dollar-for-dollar impact. Your household budget should give you an idea of what you can afford to save and can also give you an idea of how much you may want to spend in retirement.
Very few retirees will ever say they saved too much; however, many will admit regretting not diversifying the tax treatment of their retirement savings. While you may not want to give up the tax savings now by making after-tax contributions to your Roth 401(k) option or a brokerage account, once you reach retirement and you are forced into a tax situation every year with your withdrawals, you will likely appreciate the flexibility tax diversified savings will provide. For example, say your retirement savings are in tax deferred accounts, but you want to pay cash for a large purchase in retirement and need to withdraw $50,000. You may end up withdrawing more than $62,000 just to account for the necessary withholding.
Saving to a traditional 401(k) provides you with tax deferred money, while saving to a Roth 401(k) can provide you tax free withdrawals in retirement, and when saving to a brokerage account, you’ll only pay capital gains tax on the growth, but you also have control over when you choose to realize the gains and you have the opportunity to offset gains with losses.
It is good to have as many options as you can when it comes to the tax diversification of your retirement savings. However, the optimal balance often depends on your specific tax situation and can vary from year to year.
So, to answer, “How much should I save?” the answer is really, “As much as you can.” If you have questions regarding your 401(k) saving options, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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