How Much Should I Contribute to My 401(k)?
American workers can expect Social Security to replace about 40% of their pre-retirement earnings. That falls well short of the amount most will need to cover living expenses after they leave the workforce. A 401(k) can go a long way toward bridging the gap, especially if you start saving early.
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How Much Should I Contribute to My 401(k)?
Aiming to contribute 15% of your salary is a guideline that many experts recommend. But that might be unrealistic for some and inadequate for older workers who got a late start saving.
If you’re close enough to retirement age to have a sense of how much income you’ll need, and how much of it needs to come from your own savings, use an online retirement calculator, like the one GOBankingRates offers here, to work out how much you’ll have to save to get there. Otherwise, create a strategy for saving what you can now, and increasing your deferrals each year.
If your employer matches your contributions and you have some flexibility in your budget, it makes sense to contribute as much as you have to to get the maximum match. That’s free money, after all.
If your employer doesn’t match your contributions, or you can’t afford to defer that much, start with whatever you can afford, even if it’s just 1%. Then increase your contribution by 1% or 2% each year. Ideally, you’ll eventually be saving the maximum amount.
Some plans automatically increase your contributions unless you opt out. This autopilot approach can keep you on track toward your goal, and because you never see the money, it’s a relatively painless way to save.
You can also boost your savings by directing windfalls such as raises and bonuses into your 401(k) account.
What Is the Maximum 401(k) Contribution for 2024?
The IRS imposes two different kinds of contribution limits on 401(k) plans. The first is a deferral limit, which applies to the amount you contribute through payroll deferrals. The second is an overall contribution limit, which includes your deferrals as well as contributions made on your behalf, such as matching contributions from your employer.
The deferral limit for 2024 is $23,000 for employees under age 50. Employees age 50 and older can make additional, “catch-up” contributions totaling $7,500 if the 401(k) plan permits it. The deferral limit, then, is $30,500 for employees ages 50 and older.
The contribution limit for 2024 is 100% of your compensation or $69,000, whichever is less. However, that limit doesn’t include catch-up contributions. That means employees ages 50 and older have a contribution limit of $76,500.
What Happens If You Contribute Too Much To Your 401(k)?
The consequence of exceeding 401(k) deferral limits is that the IRS will count the excess amount as taxable income for the year you claimed the deferral. If, for example, you’re 35 years old and have $25,000 deferred from your pay for your 401(k) this year, you’ll have a $2,000 excess deferral and will owe income tax on $2,000.
If you let the plan administrator know and ask to have the excess distributed to you on or before April 15, 2025, you’ll report the $2,000 as income on your 2024 tax return. If you miss the deadline, the IRS will tax the money twice — once when you eventually claim the $2,000 on your tax return, and again when you withdraw money in retirement.
The excess amount distributed back to you might be subject to a 10% penalty tax and 20% withholding if you receive it after the April 15 deadline.
Where Should You Invest After Maxing Out Your 401(k)?
One of the major benefits of a 401(k) is that your contributions are tax-deferred. Once you’ve contributed as much as you can, you can keep the savings — and tax benefits — going by investing in other tax-advantaged accounts.
Individual Retirement Account
An individual retirement account is similar to a 401(k) in that you can contribute a limited amount of money each year — $7,000 in 2024, plus a $1,000 catch-up contribution if you’re 50 or older — and receive tax benefits on your contributions and growth. Unlike a 401(k), an IRA isn’t sponsored by your employer — you open the account yourself, through any brokerage you choose, and select your own investments.
You have two types of IRA to choose from: traditional and Roth.
Contributions to a traditional IRA are usually made from pre-tax income, and the account grows tax-deferred. After you begin withdrawing money at age 59.5 or older, you’ll pay income tax on the distributions.
Contributions to a Roth IRA are from after-tax income, and the account grows tax-free. You’ve already paid tax on your contributions, so your distributions at age 59.5 or older are tax-free.
Which is the better choice depends on your financial situation. If you could use the tax break now, and you expect to be in a lower tax bracket after retirement, consider a traditional IRA. If, on the other hand, you can make do without the deduction, and you expect to be in a higher tax bracket after you retire, a Roth IRA might be more beneficial.
Health Savings Account
A health savings account lets anyone enrolled in an eligible high-deductible health plan to save pre-tax money for future qualified medical expenses. In 2024, you can contribute up to $4,150 for a single plan or $8,300 for a family plan. But you don’t have to make your own contributions — anyone can contribute on your behalf.
You can open an HSA through a bank or a brokerage. Bank HSAs are similar to regular savings accounts, and you might even be able to open one at your own bank. Brokerage HSAs are investment accounts that could appreciate faster than bank HSAs, but at the risk of losing some or all of your investment. With either type, your money grows tax-free.
One nice perk HSAs provide is the ability to roll over your unused balance year after year, without limit. If you still have unused money in the account when you turn 65, you can withdraw it without penalty, for any purpose you want — but you’ll be taxed on the withdrawal. Otherwise, withdrawals for any purpose other than allowable medical expenses incur a 20% penalty tax.
Annuity
An annuity is a type of insurance contract where you pay a premium and the insurer agrees to pay you a cash benefit in return. Depending on the type of annuity and your preferences, the premium can be a lump sum or a series of payments. The cash benefit can begin immediately or on some future date, and it can last for a specific number of years or for the rest of your life.
However your annuity is structured, your premium payments will be invested, and your cash benefit will include your contributions plus appreciation. Only the appreciation is taxable — and only when you receive distributions.
It’s important to note that annuity fees can be quite high, and the tax benefits vary from one type to the next. Consider meeting with a fee-based financial advisor before you purchase one.
When Can You Withdraw Money From Your 401(k)?
You can make penalty-free withdrawals from your 401(k) beginning at 59.5 years old. But special circumstances might let you take out money before that.
Hardship Withdrawal
The IRS defines a hardship as “an immediate and heavy financial need,” such as medical expenses, tuition, eviction or foreclosure prevention, funeral expenses or home repair. Hardship withdrawals are limited to the amount needed to satisfy the need.
Rule of 55
The rule of 55 (or 50 if you’re a public safety employee) refers to an IRS rule that allows employees to take penalty-free distributions from their 401(k) at age 55 if they separate from their employer. Under the rule, you can only take withdrawals from the account managed by the employer you left, and you’ll have to pay tax on the distributions.
FAQs
What percentage should I contribute to my 401(k)?
Experts often recommend saving 15% of your salary to ensure that you have enough savings by the time you retire. However, the best amount for you depends on how long you have until retirement and how much income you'll need. The GOBankingRates' retirement calculator can help you with those calculations.
Is 6% a good 401(k) contribution?
What counts as a good contribution depends on how long you have until retirement and what other sources of retirement income you'll have. Six percent could be a good contribution for you, especially if your employer matches some or all of that amount.
How much should you have in your 401(k)?
Experts recommend having roughly 10 times your salary by the time you retire. Fidelity offers the following recommendations for various milestones leading up to retirement:
1x salary by age 30
3x salary by age 40
6x salary by age 50
8x salary by age 60
10x salary by age 67
How much are you allowed to contribute to your 401(k)?
In 2024, you can contribute $23,000 -- plus an additional $7,500 if you're age 50 or older. The contribution maximum, including employer contributions, is 100% of your compensation or $69,000 ($76,500 if you're age 50 or older), whichever is less.
Information is accurate as of April 9, 2024.
This article originally appeared on GOBankingRates.com: How Much Should I Contribute to My 401(k)?
