Financial planners can’t emphasize the importance of saving for retirement enough: The earlier you start saving and the more you contribute, the better. But should you max out your retirement account? And if so, how do you do it?
Unfortunately, there’s no solution suitable for all; every individual has a different financial situation.
But let’s start with the basics: The maximum amount of money you can contribute to your 401(k), the retirement plan offered by your company, is currently $18,000 a year if you are under age 50, and $24,000 if you are 50 or older. If you were starting from scratch, you would have to tuck away $1,500 a month to max it out by year’s end.
This is a big chunk of money. And although there are multiple benefits to saving for retirement, you may want to think twice before hitting that maximum.
Remember, this is money that, once contributed, can’t be withdrawn until age 59.5 without incurring penalties (with some exceptions).
What’s more, putting away a significant portion of their savings to max out their retirement fund doesn’t make much sense for some workers.
If you are fresh out of college and your first job pays $50,000 annually, you’d need to save 36 percent of your paychecks to max out your 401(k) for the year.
“Everyone needs to save for retirement, and the more dollars you could put in, the earlier, the better, but you also need to live your life,” says Eric Dostal, a certified financial planner with Sontag Advisory, which is based in New York. “To the extent that you are not able to do the things that you want to accomplish now, having a really really robust 401(k) balance will be great in your 60s, but that would cost now.”
A few things to consider BEFORE you max out your 401(k)
- Do you have an emergency fund for rainy-day cash? If not, divert any extra funds to establish a fund that will cover at least three to six months’ worth of living expenses.
- Do you have high-interest debt, such as credit card debt? High-interest debts, like credit cards, might actually cost you more in the long run than any potential gains you might earn by investing that money in the market. Still, if you can get a company match, you should try to contribute enough to capture the full match. It never makes sense to leave money on the table.
- Do you have other near-term goals? Are you planning to buy a house or have a child anytime soon? Do you want to travel around the world? Do you plan to pursue an advanced degree? If so, come up with a savings strategy that makes room for your nonretirement goals as well. That way you can save money for those big-ticket expenses and will be less likely to turn to credit cards or other borrowing methods.
Maximize your 401(k) contributions
If your emergency fund is flush, your bills are paid and you’re saving for big expenses, you are definitely ready to beef up your retirement contributions.
First, you’ll want to figure out how much to save.
At the very least, as we said above, you should contribute enough to qualify for any employer match available to you. This is money your employer promises to contribute toward your retirement fund. There are several different ways a company decides how much to contribute to your 401(k), but the takeaway is the same no matter what — if you miss out on the match, you are leaving free money on the proverbial table.
If you are comfortable enough to start saving more, here is a good rule of thumb: Save 10 percent of each paycheck for retirement, though you don’t have to get up to 10 percent all at once.
For instance, try adding 1 percent more to your retirement fund every six months. Some retirement plans even offer automatic step-up contributions, where your contributions are automatically increased by 1 or 2 percent each year.
Larry Heller, a New York-based certified financial planner and president of Heller Wealth Management, suggests that you increase your contribution amount for the next three pay periods and repeat again until you hit your maximum.
“You will be surprised that many people can adjust with a little extra taken out of their paycheck,” Heller said.
Once you’re in the groove of saving for retirement, consider using unexpected windfalls to boost your savings. If you get an annual bonus, for example, you can beef up your 401(k) contribution sum if you haven’t yet met your contribution limit.
A word of caution: If you’re nearing the maximum contribution for the year, rein in your savings. You can be penalized by the IRS for overcontributing.
If your goal is to save $18,000 for 2017, check how much you’ve contributed for the year to date and then calculate a percentage of your salary and bonus contributions that will get you there through the year’s remaining pay periods.