A 401(k) is one of the most effective ways to save for you and your family’s retirement. One of the most popular questions you hear from investors is, “how much should I contribute?”
Determining the right number depends on a lot of factors like your desired lifestyle after retirement, your current financial situation, and how long you have before you’re ready to clock out for the last time.
Thankfully, our 401(k) calculator can help handle the heavy lifting and get you the facts and figures you’re looking for.
What is a 401(k)?
By definition, a 401(k) is a retirement planning tool offered by employers that brings tax advantages and may be accompanied by an employer matching program. Much like a standard investment portfolio, your 401(k) can be made up of several different types of investments.
Some of the more popular investments include stocks, bonds, and mutual funds. The specific investments available to you will be determined by the provider chosen through your employer.
Once you reach retirement age, you can begin taking 401(k) withdrawals based on guidance provided by the IRS. Depending on the type of 401K you’ve chosen, these withdrawals may be available tax-free. To break down precisely what those tax advantages are, a retirement calculator may be able to help.
There are two main types of 401(k)s offered by employers — Roth and traditional. A Roth 401(k) is funded through the money you’ve already paid taxes on. The advantage of this is that upon retirement, your withdrawals will be tax-free. A traditional 401(k), on the other hand, allows you to invest money without initially paying taxes. You will pay taxes upon withdrawal at retirement, though. Choosing between the two types of 401(k) plans depends heavily on when you believe you will be in a higher tax bracket.
How much should you contribute to a 401(k)
Deciding how much to contribute to your 401(k) will depend on a lot of different factors. Ideally, the best way to determine your contribution amount is to look at two factors — your desired retirement goal and the IRS contribution limits.
First, determine how much money you’re going to need at retirement. Look at the expenses you know you’ll have and the quality of life you’re looking for. Remember to calculate in inflation, as services may be more expensive by the time you retire. Additionally, things like healthcare may become more costly as you get older.
Once you determine your goal, you can use a retirement calculator to work backward to see how much you need to contribute each year. The longer you have to save (the younger you are), the smaller your minimum contributions will need to be because of time and compounding.
You will need to look at the limits imposed by the IRS, as 401(k)s do not allow you to input unlimited funds every year.
Types of 401(k) investments
The investment options you’ll have in your 401(k) will depend on the provider that’s been selected by your employer. Unlike an IRA, you are limited to the options preselected for you. That being said, you will have several options for types of investments within the most popular account providers.
- Stocks – Many 401(k) investors like to put a portion of their portfolio in stocks. Stocks allow you to purchase a piece of a publicly-traded company. Depending on the types of stocks you invest in, you can get varying degrees of risk and potential returns.
- Bonds – Bonds are investments that allow you to lend money to a company or a government for some time in exchange for a return on investment. Much like stocks, bonds give 401(k) investors the ability to get varying degrees of returns and risk in their portfolio.
- Exchange Traded Funds (ETFs) – Stocks are often separated into several different groups known as indices, particularly for tracking purposes and to study the full market. Many 401(k) providers are now offering the ability to invest in all the companies in these indices in one fund — known as an ETF.
- Mutual Funds – One of the most popular investments in 401(k)s are mutual funds. These professionally managed investment “pools” allow you to diversify your finances quickly, without the need to make multiple investments. Often, 401(k) investors will allocate their funds heavily towards mutual funds the closer they get to retirement to continue lowering risk.
The final word
Saving for retirement is something that you can begin at any age in life. The earlier you start, though, the more time you have to reach the goal amount you need to maintain your desired quality of life. The sooner you start, the more you can save, and the better you can build your life quality for your later chapters. A 401(k) retirement calculator can help you determine your savings goals each year between now and your target retirement date.