If you work for a for-profit company, you can take advantage of a retirement savings vehicle called a 401(k). It is an employer-provided retirement account that you, and possibly your employer, contribute pre-tax dollars to, with rules and annual limits set by the federal government. Your contributions are automatically deducted from your paychecks.
Some employers offer matching programs as part of their benefits package: they will contribute a certain amount to help grow your funds. This could be a matching program, where the company matches how much you contribute up to a dollar amount or percentage of your salary. Or it could be a set contribution, where they put a percentage of your salary into the retirement account regardless of if you put anything in.
Contributions into this type of retirement account are an investment in your future lifestyle—and because they are made pre-tax (meaning you are not taxed on the amount you contribute now), they lower your taxable income in the year you make the contribution. This makes it an immediate tax benefit and a future savings benefit.
How to contribute more to your 401(k)
The first step is built into the process: the funds are automatically deducted from your paycheck, so you’re not tempted to spend the money before you can save it. If you’re not sure what the maximum contribution amount your budget can allow is, start by trying to contribute at least the minimum amount to take advantage of any employer matching funds.
From there, or even starting from 1% of your salary, considering increasing your contributions in 1% increments as often as your plan rules will allow. This slow increase in saving and decrease in take-home pay gives you more time to adjust budget, spending habits, expectations, etc.
Consider putting all or most of any bonuses or raises directly into your 401(k) account. This will inch you closer to maximizing your contribution.
When it’s a good idea to maximize
According to the IRS, the amount individuals can contribute to their 401(k) plans in 2023 will increase to $22,500 -- up from $20,500 for 2022. People over 50 may have a higher limit. These limits can change annually, so be sure to check each year, and (luckily!) they do not include any matching funds from your employer.
If you can afford to max out your contribution based on the current yearly limit without causing a large impact to your budget, it can be a great idea to really boost your retirement investments.
It’s a good idea if:
- You have at least six months of expenses saved in an emergency fund
- You do not have any high-interest debt—if you do, this needs to be paid off first. Why? Because 401(k) returns will rarely ever exceed the interest rate you pay on some credit cards or payday loans. Any debt with an interest rate at or above 10% should be paid first. (A 10% return on investment is a good average estimate to use for 401(k) accounts.)
- Your company’s 401(k) plan has solid growth rates (think about that 10% number again)
- Even with a maximum contribution, you can still afford to save for other financial goals
Early on in your career, when you are earning less, it can be harder to reach that maximum contribution amount. Instead of thinking about that number (which will change over time) as a goal, some personal finance experts suggest shooting to save at least 15% of your annual income throughout your career. For context (and minimal math on your part), that means if you make at least $130,000 in 2023, you could probably comfortably reach the $19,500 contribution limit (assuming you’re under age 50), which would be 15% of your income.
When it’s not a good idea
Two of the biggest factors that should affect your decision to not reach for that maximum contribution are your personal financial situation and the specifics of the 401(k) plan.
If you're struggling to consistently pay bills each month, don’t have an adequate emergency fund, have too much or high-interest debt, and/or the 401(k) option isn’t great, it’s best not to reach for that maximum contribution. And remember, each year should bring a gradual increase in salary and decrease in debt (if you’re managing your budget), so you can still increase the amount you’re saving toward retirement each year.
Again, for context and simple math, if you earn $75,000 this year, trying to save $22,500 for retirement would represent forgoing 30% of your total income. That’s a lot! Better to gradually and consistently increase your contributions while maintaining a firm financial foundation than to try to reach the maximum amount too soon and risk other parts of your finances or be forced to stop contributions altogether.
The other possible scenario for not maximizing your savings in this retirement savings product is if there are high fees, or you have little or no control over how your money is invested (aggressively or cautiously). If this is the case at your employer, you can always opt out of their company plan and save through an independent fund, like a traditional or Roth IRA. These accounts can provide different tax benefits, and, in some cases, more flexibility in what assets you invest in.