A common question I receive from employees is, “How much should I save into my 401(k)?”

When it comes to leveraging your 401(k), saving is the first essential component. Though many employees have questions about investing and how to invest properly, beginning the savings journey can often be the biggest hurdle.  

Generally, advisors recommend contributing between 10-15% of gross pay, per year, towards retirement.

This general rule tends to hold true for most; however, as with most financial guidance, there is no one-size-fits-all approach. Ultimately, how much you save depends on several factors like affordability, time horizon, and financial goals.

To illustrate, let’s compare Guillermo and Tabatha who are both saving for retirement. Guillermo is a 24-year-old retail store manager earning $50,000 annually and Tabatha is a 40-year-old paralegal earning $80,000 annually. Both of them plan to retire at age 65 and to live on 75% of their current pay, and both have just begun their savings journey. See their information detailed below:

Guillermo & Tabatha Chart 1

Assuming Guillermo saves 10% of his income ($5,000) per year and earns 6% on his investments, he would have $886,107 when he retires. If Guillermo lives until age 95 (a 30-year retirement window), he would be able to withdraw $3,000 per month and have some left over to leave a legacy behind^[3].

On the other hand, assuming Tabatha saves 10% of her earnings ($8,500 per year), all other factors being equal, and withdrawing $5,000 per month, she would run out of money before reaching age 75. See the graph below:

Guillermo and Tabatha Cash Flow Chart

Clearly, as represented above, there are several factors that influence the appropriate amount of savings that is right for you. In the case of Guillermo and Tabatha, time makes a difference with the power of compound growth. No matter how much you can afford to save, consider saving early and often. Start when you can and consider increasing your contribution when your income increases.

To help, many recordkeepers have an automatic increase program where you can schedule a regular increase in your contribution rate. Additionally, many 401(k) plans offer an employer matching contribution where you can receive free money that goes toward your retirement. If applicable, consider contributing at least enough to capture the full match.

If you are looking to max out, you can save upwards of $22,500 to a 401(k) in 2023, plus an additional $7,500 catch-up for those aged 50 or older. Above and beyond that, consider opening an IRA or contributing to an HSA (if you have a high-deductible health plan). Be aware, however, there are limitations on IRA deductibility if you meet a certain income threshold and are eligible for a 401(k) plan^[4].

If you are considering saving for retirement and are not sure how much to save, there are many tools and resources available online (Nerdwallet, Bankrate, Vanguard, & Schwab to name a few) and through your plan’s recordkeeper website. You can also reach out to a professional like a CFP® who can not only assist in your retirement savings journey but can also provide holistic insights on the entirety of your financial situation. Feel free to go to www.letsmakeaplan.org to find a CFP® near you.

Lastly, enough emphasis cannot be placed on setting up a budget to set yourself up for success. Knowing where your money is going can be the first step to identifying any gaps that may exist and can reveal your capacity to save. For more information on how to think about budgeting more broadly, check out my recent blog posts on behavioral bias (part 1 and part 2).  

_{[1] Nerdwallet - How Much Should You Save for Retirement?}

_{[2] This considers roughly 75% of income after savings of 10% and a 10% effective tax rate. The exact figure comes out to be $2,666 per month; however, the amount was rounded up to $3,000 to account for taxes at 10% in retirement assuming this is drawn from a pre-tax 401(k) or IRA.}

_{[3] This assumes a growth rate of 4% during retirement while drawing down on assets.}

_{[4] Nerdwallet - Can I have a 401(k) and an IRA?}

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