Are You Contributing Enough to Your 401k?
When I ask new clients (particularly younger clients) how much they are contributing to their workplace retirement plan (401k, 403b, etc.), the two most commons answers I receive are:
I don't know
Whatever the minimum is to get the employer-match
It's not uncommon for people to get caught up in the onboarding of a new job and gloss over the details of the 401k. For that reason, most people just set their contributions at the minimum amount required to get the employer-match. After that, it rarely gets revisited.
It's also a common assumption that the minimum 401k contribution to get the employer-match (typically around 3-4% of your salary), plus the employer-match (another 2-3% of your salary), will be adequate savings for retirement. But is this actually true?
Will contributing 3% to your 401k be enough to cover your retirement expenses?
Well, once again, it depends. But more than likely, it's not enough to fund the retirement lifestyle you're hoping for.
If you're under 40 years old, retirement may seem like an abstract idea in the far-off distant future; however, the decisions you make today will greatly impact that future, including how much of your salary you contribute to your 401k!
There are numerous "retirement calculators" out there, all of which have their limitations, but without paying for professional financial planning software, these tools can provide a general sense of whether or not you're moving in the right direction in terms of your savings.
Let's walk through an example:
For the example I'll be walking through today, I will be using the SmartAsset 401(k) Calculator. Here are the assumptions:
At age 25 years old, you started a job making a salary of $80,000 per year, and you expect an annual raise of about 2% per year until you retire at age 65.
When you enroll in the 401k, you elect to contribute 3% of your salary ($2,400 per year); your employer matches 100% of your contribution, up to a maximum of 3% of your salary (so the employer contributes $2,400 per year as well).
Over the course of your career, your 401k earns an average annual rate of return of approximately 7.0%. In reality, your returns will be higher in the early years and lower in the later years, as you take more risk off the table as you age, but for simplicity, we'll assume you earn 7.0% per year for your entire life.
You expect to live until age 95; meaning, you will spend 30 years in retirement, where you would like to maintain your standard of living. Ideally, you'd like to continue to be able to withdrawal your pre-retirement "salary" from your portfolio after you retire (~$80,000 per year, adjusted for inflation).
At age 25 years old, you started a job making a salary of $80,000 per year, and you expect an annual raise of about 2% per year until you retire at age 65.
When you enroll in the 401k, you elect to contribute 3% of your salary ($2,400 per year); your employer matches 100% of your contribution, up to a maximum of 3% of your salary (so the employer contributes $2,400 per year as well).
Over the course of your career, your 401k earns an average annual rate of return of approximately 7.0%. In reality, your returns will be higher in the early years and lower in the later years, as you take more risk off the table as you age, but for simplicity, we'll assume you earn 7.0% per year for your entire life.
You expect to live until age 95; meaning, you will spend 30 years in retirement, where you would like to maintain your standard of living. Ideally, you'd like to continue to be able to withdrawal your pre-retirement "salary" from your portfolio after you retire (~$80,000 per year, adjusted for inflation).
The scenario described here is pretty common. Like I said earlier, most people set their 401k contribution rate and forget about it for many years. So how will this pan out at retirement? Let's take a look…
Using the very generic assumptions above, this saving strategy would only cover approximately 62% of your annual retirement expenses. In today's dollars, that means you would be able to withdrawal only about $50,000 per year from your 401k from age 65 to age 95. That's $30,000 less than your annual salary! Yikes!
Using the very generic assumptions above, this saving strategy would only cover approximately 62% of your annual retirement expenses. In today's dollars, that means you would be able to withdrawal only about $50,000 per year from your 401k from age 65 to age 95. That's $30,000 less than your annual salary! Yikes!
As you can see, this is an issue. Simply saving the matching minimum in your 401k is likely not enough, even after you factor in the employer-matching! Unfortunately, this just doesn't provide enough savings to replace your salary when you stop working.
Generally speaking, you should aim to replace at least 80% of your annual income for retirement. Although, I would argue that you should plan to replace 100%, since those early retirement years will be spent traveling, relaxing, engaging in hobbies, etc. Think about it this way: Which day of the week do you spend the most money? For me, it's Saturday. My wife and I aren't working, we have more free time, so that's when we go out to events, restaurants, shopping, etc. I'm assuming it's the same for most people. Well, the thing about retirement….every day is a Saturday. So while people think they'll spend less during retirement, that's not the case most of the time.
So how much should you actually be saving?
Saving 3% of your salary only gets you to an "income replacement" of about 62%. Meaning, saving 3% of your salary every year until retirement will only provide enough funds for you to withdraw about 62% of your pre-retirement salary from your 401k once you're retired. So you can forget about "traveling the world".
In order to get that number up to 100%, you'd need to save closer to 7%, and that's assuming you don't want to increase your standard of living. If you imagine an active retirement filled with world travels, new hobbies, and a beach home, this number would need to be much higher. Or if you plan to retire earlier than 65, then that would also increase the needed savings amount.
Of course, this does not factor in Social Security, but for those individuals under 35, I would not count on Social Security being a major source of income during retirement. Social Security will likely exist in some form in 30 years, but I wouldn't depend on it if you can help it. A better solution would be to prioritize savings TODAY so that anything you receive in Social Security is just gravy.
This is why I generally recommend saving 10-15% of your annual household income. This may sound like a lot, however, you don't have to start saving that much tomorrow. A great, feasible strategy for getting to a 15% savings rate is by starting at 8-10% then increasing your contribution rate by 1% every year (or every time you get a raise). This gradual increase makes the burden a lot more bearable, and it slowly builds good savings habits over time.
More importantly, putting away this much increases the likelihood of actually achieving that retirement lifestyle you see on the front of magazine covers; or better yet, the retirement lifestyle that brings personal fulfillment. But this financial freedom doesn't come easy. And it doesn't come from simply putting away the bare minimum in your 401k. It requires discipline, consistency, and sacrifice, year-after-year.
While this is a very simple scenario, I hope it conveys the importance of planning early, and the importance of being intentional about how much you’re saving. The seemingly simple decision around how much you should put towards your 401k is perhaps one of the biggest factors influencing your future lifestyle.
Now what?
Check how much you're actually contributing to your workplace retirement plan
If you don't know the login to your 401k account (Fidelity, Schwab, Etc.) then you should revisit your employee benefits package, which should have more information on accessing your 401k. If those documents are long gone or buried in a pile of paper somewhere, a member of HR at your company should be able to get you what you need. Once you login, you should be able to access your "Contribution" amount (usually shown as a percentage).
Determine how much you should be contributing
How much you should be saving depends on a multitude of factors, but don't simply assume that because you're contributing the minimum to your 401k, then all is well. It's better to figure that out now rather than learn the hard way 30 years from now. So check out some of the calculators listed below, or better yet, for a more precise answer, consider engaging a fiduciary financial planner to get the right answer for your personal planning needs.
Remember your "Why?”
Adjusting your savings contribution may be difficult at first, and it may require some lifestyle adjustments. But as your passing up DoorDash for a homemade meal, or giving up Starbucks for a homebrew, take the time to reflect on your "Why?" Remind yourself of why you are making these small sacrifices today. Understanding and reflecting on what really matters to you makes the sacrifice of saving today feel small in the grand scheme of fulfilling your long-term life vision.
Retirement Calculators: