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How To: Plan My 401(k) Contributions

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 [3]. 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 [4]) and I knew I wouldn’t miss it. This was exactly the same logic that led Paid Twice to set her contributions at 2% [5] 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 [6] (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.