How Much Should I Invest in My 401k?
Investing money in your 401k is one of the best ways to prepare for retirement, but it can be difficult to determine the optimal level of contributions. With so many different investment options vying for your hard-earned cash, it can be difficult to tell what option gives you the most for your money.
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Company Match
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At the very least, you should invest enough in your 401k to get the full company match. If you fail to invest at least that much, you are literally turning down free money -- something you would never do under any other circumstances. Just consider the average worker who makes $30,000 a year. If the employer matches 50 cents on the dollar for the first 6 percent of income, failing to participate in the 401k plan is the same as turning down $900 in free additional income.
Tax Savings
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Keep in mind that every dollar you invest in your 401k is one more dollar that is deducted from your taxable income. That means if you earn $40,000 a year and contribute 25 percent to your 401k, you are taxed on only $30,000 in income. The value of this up front tax savings can be substantial, and it is yet another reason why you should invest as much in your retirement plan as you can.
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Automatic Escalation
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Many 401k programs now include an automatic escalation option. If you sign up for this option, the amount you contribute to your 401k is automatically increased each year, sometimes on your anniversary date and sometimes at the beginning of the year. This is a great way to boost your retirement savings painlessly, since the increase simply kicks in on schedule with no action required on your part.
Other Options
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If you cannot afford to max out your 401k and still contribute the maximum to your Roth IRA, you might want to max out your Roth IRA first, especially if you have many years to go until retirement. Putting money into your Roth IRA is one of the best ways to build a tax-free stream of income you can tap in retirement, and the value of decades worth of tax-free growth can be enormous. One smart strategy is to invest enough in your 401k to get the full company match, then invest the full amount in your Roth IRA. If you have additional cash flow available, you can boost your 401k savings to get even more tax savings and long-term retirement growth.
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