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How To: Plan My 401(k) Contributions

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When I started working back in 2003, I was introduced to the beauty and power of 401(k)’s and how my employer would match fifty cents on the dollar to the first 6% of my salary I was willing to put towards my own future. I immediately saw it as a way to take advantage and get a 3% raise as well as put a large chunk of money away for the future. The 401(k) was my money time machine, allowing me to send some money to the future, money that could be fruitful and hopefully multiple if I made good sound decisions. The only question at that point was how much I should I put in my money time machine?

Many experts would argue that you should work backwards. Set your goals based on careful thought (“I want $10 million in my retirement fund when I’m 65) and then set your retirement contribution based on those goals, given dangerous assumptions like 10% annual growth. For some, that’s a great way to plan but that’s not something for me. There are simply too many variables for me to say that my target number is this, my growth rate is this, let’s start saving! Instead, I go the other direction, I plow as much as I reasonable can and see what happens! (did you expect something more structured? sorry!)

Setting Initial Contributions

When I started, I did was Paid Twice did, I put in as much as I would not miss. For me, that was the maximum contribution! (it’s crucial to do this when you’re still in the poor college kid mentality!) I went from earning a modest four or (really low) five figure income hawking items on eBay, selling freelance software I wrote, and other little online ventures to a legitimate job with a legitimate salary. My expenses had gone up for sure but I knew I had enough room to put ~20% of my salary (I would later reduce that to buy a new home) and I knew I wouldn’t miss it. This was exactly the same logic that led Paid Twice to set her contributions at 2% when she first started working.

Changing Your Contributions

As your life situation changes, your money needs also change and it’s important to identify those situations. I contributed the maximum amount for two years and then pulled the amount back to the minimum contribution for the maximum employer match. I did this so I could route the difference (minus taxes) to an account focused on saving for a house I wanted to buy within the next three years. It’s important that you make these adjustments so that you can foster sound decisions down the road. Had I kept contributions to the maximum, perhaps I would be tempted to raid my 401(k) funds, which is widely regarded as a bad idea.

You can also change your contributions based on your changing situation on the income side too. Many people increase their 401(k) contributions as they receive raises. If you get a 4% raise, maybe you increase your 401(k) contribution by another half or full percent (or more!). You don’t “feel” it because you still get an increase, though some would argue 4% is cost of living/inflation and not really a merit based increase (I would argue that, which means I’ve never received a “raise,” just COL adjustments!).

Is More Better?

In the very general, I believe so, but I’ve also said that you shouldn’t invest in the stock market (where most of 401(k) money goes!) and that everything should be in moderation. You can contribute too much and put yourself in a situation where you’ll need to take money out, sometimes at a 10% penalty; so please exercise moderation in this and all things.

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10 Responses to “How To: Plan My 401(k) Contributions”

  1. Frugal Dad says:

    What do you say to those who recommend only investing through a company match in 401k’s and plowing the rest into a Roth IRA? Seems like a good way to hedge the post-retirement tax hit, but I’m wondering about reducing the compounding effect by having your funds spread across multiple accounts. Great post, by the way!

  2. jim says:

    I think you need to diversify your tax profile, so my strategy was always to put the minimum amount to get the maximum match, then fill up the Roth, than go back to the 401k. Each person has their own “best” method but that was mine… then they threw in the Roth 401(k)!

  3. paidtwice says:

    Thanks for including my story :)

    Do you have a Roth 401K at work? We don’t so we don’t have to worry about that yet :)

  4. Adfecto says:

    I started contributing enough to get the full 401(k) match, next I opened a Roth IRA and set up regular automatic contributions. Then with each raise I allocate half of the take home to increasing my savings. I never miss the money.

    As it stands now I put 8% into my 401(k) and $100 per pay period into my Roth. This Summer I will (very likely) get about a 4% raise which will be just about enough after taxes to finish maxing my Roth IRA. January ’09 I will, again with a little luck, get a cost of living adjustment of about 4% so I will increase my 401(k) to ~10%.

    This approach can work for anyone and you will never even miss the money. Even back when I made about half of my current salary it worked just fine. By using a percentage based system it lets your savings grow as your income grows. When you do start pulling down six figures one day, you won’t even miss the $15,000+ you are saving each year.

  5. Grace says:

    A slight off shoot to the 401(k) topic, here’s my question and would love to have your feedback:

    I have 3 401(k)s from previous employers that I have been too lazy to rollover. My current employer’s 401(k) fund choices are really good, so it’s in my interest to roll them over. Unfortunately, due to current market conditions, my 401(k) balances have gotten a 25% haircut. Do I roll the plans from previous employers over to my current employer now or hold off until things improve? I know, who’s to say if and when things will improve, but if my current employer’s fund choices are good, wouldn’t it be wise to get in now as the mutual fund shares are cheaper? Please advise, thank you!

  6. jim says:

    Grace: I think the 25% loss shouldn’t play a role in your decision making because that 25% loss was like the tide, everything went down. As long as you aren’t trying to time the market by sitting on the sideline, as you may be tempted to with a taxable brokerage account, I think the other factors are more important. You may find the fee savings are significant, plus the headache of managing (or ignoring) so many accounts.

  7. GBlogger says:

    Neither my wife nor I get any matching on our retirement contributions, but we both have the Roth option on our 401ks. I also have another plan available to me through my company that is separate from 401k but can only be pre-tax. In total, our contributions are currently around 60% in pre-tax and 40% in Roth.

    I really like the part of this post on “Changing Your Contributions.” It’s important to push to save for retirement, including through your main vehicles like 401k, but I agree with the idea that you should accommodate the rest of your circumstances as well (and that those will change).

  8. Anonymous says:

    Frugal Dad: You do not lose any compounded interest benefit by spreading monies across accounts. Don’t worry about that. The risk is all in the return.

  9. 2million says:

    Jim, Am I reading this wrong or are you saying you have a low six figure income in college?

  10. jim says:

    2million: Not sure where you got college but I never earned six figures from my job.


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