A guide to 401(k) plans
If your employer offers a 401(k) plan, it’s your primary ticket to a comfortable, secure retirement. There are limits on how much you can contribute, but they’re generous. In 2022, you can save up to $20,500 in your 401(k) plan — up from $19,500 in 2021. (Workers age 50 or older can put in an additional $6,500.) And contributions are deducted from taxable income, so you get even more bang from your bucks.
When you’re just starting out, maxing out your contribution can be a challenge. The general rule of thumb when it comes to saving in your 401(k) is to try to contribute 12% to 15% of your gross income. If that’s too much, resolve to put in at least enough to qualify for your company’s matching contributions.
Most large companies offer a match — typically, an employer will contribute from 50 cents to $1 for every $1 the employee puts in, up to the first 6% of pay. If you’re unsure how much you need to contribute to get the match, ask your human resources department or the plan provider.
If your company doesn’t offer a match, or if the company contribution isn’t dependent on your contribution, saving 3% of your pay is usually a good place to start, says Samantha Gorelick, a certified financial planner based in New York City. Once you’ve created an emergency fund and paid down high-interest debt, you can focus on increasing the amount of your 401(k) contributions.
Some companies have auto-escalation clauses in their 401(k) plans, which means they’ll automatically increase your contribution over time. You can usually opt out of auto-escalation, but increasing your contributions will go a long way toward helping you reach your retirement goals. “We recommend potentially increasing the contribution by 1% every six to 12 months,” Gorelick said. Consider increasing your contribution rate every time you receive a raise or bonus.
There are two kinds of 401(k) plans: the traditional 401(k) and the Roth 401(k). As mentioned above, contributions to a traditional 401(k) are made with pretax dollars. That means you’ll avoid taxes now and instead pay taxes on the money when you take it out.
With a Roth 401(k), contributions are made with after-tax money, but withdrawals are tax- and penalty-free, as long as you’ve had the account for five years and are at least 59 ½ when you take out the money. If you receive matching contributions from your employer, they’ll go into a traditional 401(k) account.
There are a number of reasons to opt for a Roth 401(k), or to have a combination of both types of plans. Investing in a Roth 401(k) while you’re young will provide more time for your investments to grow tax-free rather than just tax-deferred. And unlike Roth IRAs, Roth 401(k) plans aren’t subject to income limits, making them a good option for high earners who are ineligible to contribute to a Roth IRA.