When it comes time to fill out your 401(k) paperwork, you might be totally confused about how much to contribute. I know I was. Some companies match a percentage of your contribution, so that’s always going to encourage you to contribute more.
After doing my own research, it seems like the key to understanding what you should contribute to your 401(k) lies in understanding how a 401(k) works, so let’s start there, moving through what the average American contributes to a 401(k) and touching on how to know your 401(k) is a good one. Armed with a little information, you could be kicking 401(k) butt in no time. I feel like I am now.
Let me begin by saying I’m not a financial adviser — this is just my opinion after doing my own research. It was research I needed to do, because, I’ll be honest — for a long time, investing in my 401(k) was not as big a priority for me as it should have been. When I was in my early 20s, I believed it was more likely I’d become a rock star writer for something like The Rolling Stone, following in the footsteps of my heroes. Guys like Hunter S. Thompson and Matt Taibbi. Certainly ninja warrior writers like those guys don’t worry about trifles like their financial futures, right? Haha. Thankfully, I came to my senses, and started contributing to a 401(k) seriously a few years ago. (I still feel like a rock star writer.) Had I started earlier, though, I might be retiring with almost twice as much money.
I can tell this by looking at any 401(k) calculator out there. Take the one at Bloomberg. Without sharing my salary with you, I can tell you that the difference between 40 years of contributions to my 401(k) and 33 years of contributions (I’m 27 years old and definitely plan to work at least until I’m 60.) is literally double. This has to do with the way an investment compounds over time, but the key is to start early like Ralph Macchio in The Karate Kid. (Think of all the extra he made in sequels and later, in appearances.) Put simply, a little more money growing at a consistent rate for a little bit longer means a lot more money when you retire. That’s how a financial black belt would do it.
If you want to do The Crane on your 401(k), that’s going to mean getting into good habits early… like waxing the car, painting the fence, sanding the floor…
A 401(k) is a bit of a weird thing, the way I see it. For one, 401(k)s have only been popular since the ’80s, because before that, employers generally covered their employees’ retirements, in the form of pensions. Today, a 401(k) and retirement are really thought to be the responsibility of the employee. (Though, as I stated earlier, companies will often match a percentage of your investment.)
Beyond that, you should understand that a 401(k) is a way to invest pre-tax income into your future. This is generally why A) it makes sense as a way to put money away for the long haul and B) companies are still tied to the process of investing in a 401(k). Your company puts whatever you decide into your 401(k) and you don’t pay taxes on that money until after you take it out of the 401(k). This means you should A) expect to be able to contribute a little more than you might realize, in terms of a dollar figure, and B) also expect to pay tax on that money after you take it out. What looks like a ton of money in your 401(k) might not feel like as much after you’ve paid taxes on it. This is an investment you should be extra, well, invested in growing by contributing to it! Like Bruce Lee, if you want to look like a ninja when it comes to your 401(k), it’s best to truly be a ninja.
…Taking a little time to understand this stuff seems totally worth it when millions of dollars are potentially at stake, no?
As you might expect, Fidelity, a big dog in the 401(k) business, reports the average 401(k) on their books right now has more in it now than in the last 10 years. Moreover, The Wall Street Journal recently reported that about 60% of the households in America “nearing retirement age” have a 401(k). Also, according to Fidelity, more people have been upping their contributions than reducing them for almost two years, so it seems fair to say that most people have a 401(k) and that most people are contributing more to it.
Fidelity provides over 51 million Americans their 401(k)s, and they say the average contribution is 8.2% of a person’s annual income. Dave Ramsey, a popular personal finance guru and friend of PerkStreet, suggests contributing 15% of your income to your 401(k). I’m currently setting aside 10%, but as soon as my debt is paid off, I’m going to follow Mr. Ramsey’s advice and boost my contribution. Why? According to The Wall Street Journal and other publications, many Americans who are preparing to retire don’t have enough in their 401(k)s to retire comfortably.
Like Splinter, the wise master of the Ninja Turtles, it’s good to learn by observation. Knowing what’s “average” matters, which is why I included it, but you should also ask your co-workers and friends what they contribute. This will give you a sense of where you really fit in your demographic. …Talking about this stuff can prevent you from winding up eating pizza in the sewer.
According to the IRS, the maximum you can put into a 401(k) this year is $16,500, unless you’re over 50-years-old, in which case you can sock another $5,500 away to “catch up.” That limit includes your contribution only.
If you’re curious about how your 401(k) is performing as an investment — and perhaps more importantly how many fees you’re paying on a plan your company selected for you, inquire with your HR department about that. Remember that your 401(k) is an investment portfolio of mutual funds comprised of stocks, bonds and money market accounts. It’s growth is contingent on the whole economy. That said, most of the advisers online who’s suggestions I’ve read seem to indicate that a good 401(k) plan is something you shouldn’t have to go in and change as the stock market waxes and wanes. Remember this is a long-term investment. Make a plan, make sure it makes sense and see it through with the commitment of a Samurai Warrior.
If you do want to alter the mix of your 401(k) mutual funds, many employers have plans that are flexible enough to let you do that. A Fidelity 401(k) I had years ago allowed me to select how risky I wanted my investment to be — I was advised to select a bit more high-risk portfolio since I was young, but I could see just as much sense in taking the other road given the length of time an investment like this grows. If you’re curious whether the 401(k) your company offers is “good” in general, I’d suggest checking out BrightScope, which we’ve written about here on the PerkStreet Blog before.
Like Tom Cruise in the film The Last Samurai you need to know who’s a true ally to you when it comes to retirement. Look into your company’s 401(k) plan, compare it to others and make sure you’re getting a fair match. If your inquisition makes your future look grim, it might be time to start fighting for another side.
Common sense should tell you to contribute as much as you can while your employer is matching you. That’s free money you’re getting from the boss. But ultimately, you have to think about what’s comfortable for you to contribute and put that much in each month. Break down your budget and make sure you know what you can afford. Any more would be silly because you could be throwing yourself into debt by living beyond your means. Having to use evil credit cards to survive because you’re contributing too much to your 401(k) would make less sense than Chuck Norris becoming a golden hero to Modern Day teens… Oh wait, that happened?
Do you think Chuck Norris would have become as famous (or as tough) as he did without being willing to do what was right for him? Being the first-ever American ninja superstar wasn’t easy and neither is figuring out what you can personally contribute to your 401(k). Show no fear if you find yourself face-to-face with some more soul-searching and research when it comes time to make the decision about how much to contribute.
…And never forget that when Chuck Norris invests in a 401(k), the 401(k) actually gets visibly more muscular the very same day. Sign me up!
What do you think is crucial for people to understand in order to be smart about their 401(k) decisions? Please share in the comments section below.