How Much of a Percent of Your Income Should You Put Into Your 401(K) When You Are Young?
Financial experts recommend that young adults begin saving for retirement as soon as possible. 401(k) plans are employer-sponsored retirement accounts that are subject to federal pension laws. Under federal law, employees can begin saving for retirement at age 18. How much you should save depends on several factors, including the state of the economy, the individual growth of your 401(k) investments and the age at which you begin saving and plan to retire.
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Overview
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401(k) pension plans are defined benefit contribution accounts established by employers and are subject to the Employee Retirement Income Security Act (ERISA). Although the ERISA does not require employers to establish 401(k) accounts for their employees, it sets forth minimum contribution guidelines. Employees can make pretax contributions to their 401(k) plans that are not subject to federal and state income taxes. If you retire at or after the federal minimum retirement age of 59 1/2, you can withdraw your funds without paying penalties.
Employer Matching Programs
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If your employer offers a 401(k) plan, your employer might offer a matching contribution and match the amount you save. As a deferred compensation account, your 401(k) investments grow tax-free until you withdraw your funds. As such, they are great tools to save money and also serve as effective tax shelters. You can calculate the amount you should save before age 30 by using a retirement 401(k) planner or worksheet. SmartMoney offers a free 401(k) planner and worksheet, which you can use to calculate your retirement needs based on your age and estimated rate of growth.
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Hypothetical Scenarios
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For example, based on the SmartMoney calculator, if you begin saving at age 30, and you plan to contribute 5 percent of your current salary of $50,000 for the next 30 years, using a hypothetical constant 5 percent rate of growth, your 401(k) balance will be $360,632.14 in 30 years. This figure also assumes that your employer will match your 5 percent monthly contributions and will give you a 3 percent raise annually. However, if you contribute an additional 1 percent, and your employer gives you a 6 percent match annually, your 401(k) balance at the end of 30 years will increase by over $100,000. At the end of 30 years, you will have saved $478,822,75.
Factors Affecting Retirement Needs
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At the very least, you should save at least as much as your employer offers through its matching program. If your employer offers a 5 percent match, you should make sure you contribute at least 5 percent to your 401(k) program. The earliest age that you can retire without paying a prepayment withdrawal penalty on your 401(k) contributions is 59 1/2. If you delay your retirement by a few years and you retire at age 65, you have almost six additional years to continue saving for retirement.
Prepayment Penalties
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If you withdraw your funds before reaching retirement age, you are subject to prepayment penalties, unless you withdraw your funds pursuant to divorce and a Qualified Domestic Relations Order (QDRO), as an estate administrator, or for disability. You are subject to federal income taxes and may have to pay state income taxes upon withdrawing your retirement assets.
Other Considerations
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If you plan on retiring earlier, then you must save more monthly to make up for the deficit. According to the official U.S. Department of Labor publication, "Top 10 Ways to Prepare for Retirement," you may need to save about 70 percent of your current income for retirement. In other words, you will need about two-thirds of your current monthly income for your monthly post-retirement expenses.
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