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74% of employers offer a 401k retirement plan or something similar, according to Transamerica Center. If you are fortunate to work for one of these companies, then you might want to make sure you are contributing the right amount to your 401k to retire comfortably while living happily today. I will give you a step by step process that will help you decide what 401k contribution rate is best for you.
This first step is also the most important when calculating your 401k contribution rate. Figuring out how much you need to retire is important for your future. If you know how much you need to retire, great! You can move on to the next step, if need a little more help getting this number, keep reading.
For those of you that do not know how much you need to retire, use the “multiply by 25” rule. It’s quick and easy without getting technical. With this rule you will multiply your current salary by 25 and that is the minimum amount you will need at retirement. For example, if you make $50,000 per year you would need $1.25 million for retirement.
$50,000/year x 25 = $1,250,000
See how painless that is. So, what’s your number? You will need it for the next step.
Now that you know how much you need to retire, let’s figure out how much we need to save each month to reach our retirement money goal. Use this calculator to help you find out your monthly savings amount for your retirement.
If you want to skip the calculator, just assume your salary is $50,000 per year and you will need to save $830 per month for retirement. You will need this information for the next step.
To help you reach your monthly retirement goal savings, let’s see how much free money your company is willing to give you. Many company’s offer 100% match up to 3% of your salary or 50% match up to 6% of your salary. Talk to your HR representative to find out what is available to you.
I strongly recommend you take full advantage of this 401k match opportunity. Like I said, it is free money. This free money will get you to your retirement money goal a lot faster and easier.
Using our example of $50,000 per year salary, let’s say your employer matches 50% of your contributions up to 6%. If your 401k contribution rate is the entire 6% to get the full match, you will have a combined total of $375 deposited into your 401k account each month.
Now that you know about your employer’s match, how much more do you need to set aside to reach your goal? If you have reached your goal by contributing to your employer’s 401k with the matching, congratulations!!! You are well on your way to a great retirement. If you still need to save more money for your retirement goals, keep reading.
Now that you have matched your employer’s 401K contribution rate, what are you going to do with the rest of the money you need to save for retirement? If you are eligible for a Roth IRA, I recommend you save your remaining amount there until you max it out. Once you max out your Roth IRA, then contribute more to your 401K.
There are different eligibility requirements, withdrawal rules, income limits and tax benefits for each. Please check with your tax and/or accountant professional because these can vary on a case by case basis.
For more information about IRAs, read Roth Vs. Traditional IRA: Retirement Basics
Still using our example of $50,000 per year salary, we still need to save $455 per month for retirement ($830-$375=$455). I recommend contributing the $455 per month to a Roth IRA. This amount will max out your Roth IRA. If you want to contribute more to retirement, you will need to contribute more to your 401k or open a traditional IRA account.
Wow, we have accomplished a lot in this post. You know how much you need to retire, how much you need to save each month, maximizing free money from your employer for retirement, and now you are on your way to a great retirement.
How did you decide what was the best 401k contribution rate for you?