When your employer offers a 401(k) plan, you have a great opportunity to save for retirement. You'll want to contribute at least enough to get the full employer match, if your employer offers one. Beyond that, here are some ways to know how much to allocate to your plan.
Decide how much you'll need
It helps to first decide how much money you think you'll need to live on after retirement. You'll also want to consider other sources of income you may receive, like Social Security benefits. (If you have a partner, it's good to plan together, but you probably don't want to rely solely on your partner for retirement funds.)
Also consider how long your money needs to last. According to the Social Security Administration, a man turning 65 today could expect to live to see his 84th birthday, on average, and a woman could expect to live past age 86.
So if you retire at 65, you could need cash for a couple of decades or more. To cover that span, financial experts suggest it's best to only withdraw 3-4% from retirement savings each year. The NerdWallet retirement calculator can help you crunch numbers.
Say you're 25 years old and want to retire at 65. You have 40 years to build a comfortable nest egg. Assume you make $50,000 a year, and your goal is to live on $50,000 annually in retirement. If you plan to withdraw 4% annually from savings once you retire, you'd need to have about $1.25 million at retirement.
According to the calculator, you can reach that goal if you allocate about 7.5% of your income, or $3,750 a year, to your 401(k). (This assumes the savings earns 7% annually, and you continue working and progressing in your career until age 65.) If you're 35 years old, you'd need to save around 18%, or $9,000 annually.
In 30 years, a million dollars may be worth quite a bit less due to inflation, so you may want to save even more. It's a good idea to talk with a financial planner to review your specific situation.
Decide what you can afford
Along with saving for retirement, you'll still need to pay for today's expenses and build up an emergency fund. If it's a stretch to fully fund your 401(k), you could contribute a smaller percentage now, then gradually increase it each year.
For aggressive savers, it's important to know that the IRS imposes contribution limits. The amounts change from year to year, based on cost of living adjustments. Once you reach age 50, the IRS limits increase to allow you to “catch up” before retirement if you didn't contribute the maximum amount when you were younger.
Knowing how much to allocate to your 401(k) is an important part of retirement planning. By figuring out how long you have to save and how much you'll need to retire, you can take steps today to secure a comfortable future.
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