You Work Hard, Make Your 401(k) Plan Work Harder

Does your employer offer a matching contribution to your 401(k) plan? If so, find out how much you need to save to qualify for that match. The most common match formula is 50 cents for every dollar saved, up to 6% of your pay. Employees participating in a plan with this type of formula need to contribute at least 6% of their salary to their 401(k) plan to get the maximum possible employer matching contribution to their 401(k) plan.

Saving 6% of your pay in a 401(k) plan and earning a 3% employer matching contribution means you are tucking away an amount equal to 9% of your salary each pay period for retirement. So a worker earning $75,000 per year would have a total annual 401(k) plan contribution amount of $4,500 that year, plus another $2,250 in employer matching contributions. The employer match is a powerful incentive to participate in and contribute to a 401(k) plan—essentially allowing you to earn “free” money from your company—that will help you get closer to your retirement savings goal.

If your employer does not currently offer a matching contribution, it still makes sense to contribute to your plan on a regular basis for three important reasons:

• There are tax advantages. In a traditional 401(k) plan, your contributions to a 401(k) plan are excluded from your gross income for that year, resulting in a lower taxable income for that year (although you must pay taxes on the distributions). Some employers also offer a Roth 401(k) plan, in which you pay taxes at the time of your contributions to your 401(k) plan account, but eligible distributions from your account are generally tax-free.

• Your money potentially grows tax deferred. If you had earnings in a savings account or brokerage account, you would have to pay taxes on the earned interest, dividends or other income at the end of the year. With a 401(k) plan, your earnings roll back into your retirement plan account and are not included as income on your tax return until the year in which you withdraw assets from your 401(k) plan retirement account. As a result, your account balance has the potential to grow faster.
  

• Interest on your savings compounds. This is what makes a 401(k) plan so powerful. Any reinvestment of interest, dividends or other income you receive within your 401(k) plan account means you can potentially earn income on your original principal plus additional income on the interest, dividends or other income you earn within your 401(k) plan account. Over the short term, the gains may appear small. But over time, you can experience larger results.

Taking advantage of a company match helps you capture valuable contributions from your employer, but it may not be enough. Many 401(k) plan providers recommend saving around 10% annually over the course of your career.³ But, the average 401(k) plan contribution is closer to 7%.⁴

If you are unable to save 10% to 15% of your pay at the beginning of your career, consider gradually increasing your deferral rate over time. One tactic to consider is boosting your 401(k) plan deferral rate every time you get a raise or bonus. This may enable you to save more without reducing your take-home pay.

Another strategy to consider to enhance how much you save for retirement is to increase your deferral rate by 1% every year. Some companies offer an automatic escalation feature in their plan that periodically increases your contribution rate with a simple click of a box, while other companies may structure their plan to require you to manually make this change.

Consider reviewing your contribution amount during open enrollment when you’re looking carefully at other benefits elections, such as medical and dental insurance, since the amount you put towards these benefits will have an impact on your paycheck. Another good time to consider revisiting your contribution amount is when you receive additional compensation, whether through a raise, promotion or bonus.

For 2024, the maximum amount you can contribute to your 401(k) plan annually is $23,000. If you’re 50 or older, you’re eligible to make “catch-up” contributions up to an additional $7,500—for a maximum possible 401(k) plan contribution of $30,500 in 2024.⁵

When you max out your traditional 401(k) plan contribution limit, you not only save more for retirement, but you also potentially pay less in taxes that year since your taxable income would be lower. That’s because traditional contributions to your 401(k) plan are taxed when they are withdrawn, not when they are contributed to your retirement plan account.

To max out your 401(k) plan contributions in 2024, you’ll first need to calculate the percentage of your annual pay that adds up to $23,000 (if you are age 49 or younger) or $30,500 (if you are 50 or older). For example, a 42-year-old worker earning $140,000 annually would need to contribute approximately [16.4%] of her salary to her 401(k) plan to reach the contribution limit in 2024. Consider adjusting your deferral rate after you receive a raise or bonus to avoid exceeding the 401(k) plan contribution limit.