Four years ago, I knew very little about saving for retirement. But I didn’t need to know anything yet, since I had just graduated and I was more worried about getting a job than saving for retirement. Once I landed that great-paying job though and got my first paycheck, I had to decide how much to contribute to my 401(k).
Saving and investing for retirement isn’t something they teach you about in school(they should though!). So it’s up to you to independently do your own research and figure out what to do. I am shocked and sometimes appalled at the lack of knowledge my co-workers have when it comes to investing. I’m talking about the basics: the difference between a 401(k) and a Roth, the tax treatment of 401(k) contributions, etc.
It’s funny how conscientious people can be about their every day finances but so lackadaisical when it comes to retirement. People are living longer than ever, things are getting more expensive and taxes are going up. This all leads to a higher cost of living in the future and the more money we’ll need in retirement. The current 401(k) system sucks and it doesn’t work for most people because it gives them the option to contribute. Most people would rather see a larger paycheck today so they tend to contribute less.
I would much prefer a system like Australia’s, where employers are forced to contribute 9% to a Suncorp superannuation fund. Unlike social security, the money is still yours though. I prefer this ‘forced contribution’ since it’s kind of like an auto-deduction from your paycheck. You’re essentially getting the same salary, but 9% of it is automatically siphoned off to your retirement account. Most of us don’t live in Australia though, so we need to figure out how much to contribute ourselves.
The Bare Minimum
The minimum amount to contribute is usually pretty easy to determine: you’ll want to contribute at least up to your company match. Pretty obvious right, why would you turn down free money? I can’t think of one good reason not to contribute up to your company match.
For those who do contribute the minimum, great job but you should probably be contributing more. Successful people don’t ever become so by doing the bare minimum. Why would you go through your whole life over-achieving in school, in sports and busting your ass at your job but only contribute the minimum when it comes to retirement? That baffles me.
So What’s the Right Number?
I’ve thought a lot about this question over the past few years and I’m still trying to find an eloquent way to answer it. I think a lot of new grads tend to get too accustomed to living off their parents during college and once they’re on their own it’s natural to want that same lifestyle. All students don’t follow this path. Many will take out loans for undergrad, find a job and work around the pursuit of a flexible setup such as night classes or pursuit of an online mba program.
Most people need to have their ‘investing epiphany’ before they realize the benefits of compounding interest. Save a lot now so that you can have your money working for you for 40+ years and earning interest that whole time. I was 22 when I had my ‘epiphany’ and since then, I’ve worked hard to make as much as I could so that I could save as much as I could.
I’m fortunate to have had my epiphany early on and that determination has allowed me to amass a 6 figure retirement portfolio by the tender age of 26. Go type those numbers into a retirement calculator and maybe you’ll have your ‘investing epiphany’ too. Too lazy? Ok, you’d have about a million dollars in your retirement account(assuming a conservative 6% return over 40 years) when you retire at the age of 65. That’s without ever contributing another dime for the next 40 years. Reason enough for you to save?
Increase the Contributions
Even though I now max out my 401(k), Roth IRA and HSA it wasn’t always like that. I started off slow with a 401(k) contribution up to the match but every year I would add 1% to my contribution. A lot of employers actually have programs that you can sign up for that will automatically increase your 401(k) contribution each year. Since there are new tax laws going into effect and older ones expiring every year, your paycheck from year to year will always differ, so you shouldn’t even notice a 1 or 2% change.
I’ve talked before about how contributions matter more than performance when you’re young. And the best way to increase your contributions without affecting your take home pay is to use your raises and merit increases to offset your contribution increases. I’ve gotten a 2-4% merit increase every year and as soon as I got it, I would always go into my 401(k) and increase my contribution by that exact amount.
I don’t think it’s fair to provide specific guidelines to how much you should contribute to your 401(k) since everyone’s situation is so unique. One person might have student loans at 6.8% to pay off and another might live in an ultra-expensive city like New York or San Francisco.
I can provide a minimum and a maximum percentage but it’s up to you to determine everything in-between. If you like the idea of turning $100,000 into $1,000,000 in 40 years without having to do anything other than plopping your money into a basic target retirement fund, maybe you should be closer to the maximum.
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Readers, how much do you contribute to your 401(k) each year? What percentage of your salary is it?