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Choose the Right Contribution Rate for Your 401(k)

Brian O'Connell


There's really no getting around it -- choosing the optimal 401(k) contribution rate is serious business -- akin to laying the foundation of a new home, or planning a household budget before raising a family.

Your 401(k) contribution rate -- the amount deducted from your check every pay period that is redirected toward your company retirement plan, in percentages -- will set the financial tone for your retirement plan growth. Deduct from it and your retirement could wind up in serious peril.

But if you add to it, your golden years will become that much more golden.

So how much of your paycheck should go to your 401(k)? The data deviates on the issue, but money managers say anywhere between 10 to 15 percent is a great place to be, retirement planning-wise.

That said, current lifestyle financial needs, such mortgages, rent, college loan, credit cards and auto payments -- among other household expenditures, may well limit the money you can contribute on a regular basis to your 401(k).

[See: 10 Long-Term Investing Strategies That Work.]

Under that scenario, there are a few key questions to ask before pinning down a 401(k) contribution rate number. What are the factors that go into a specific saver's rate, and why? Is there an ideal contribution rate? Is there a "bad number" that needs avoiding?

Talk to a retirement planning expert and you'll start hearing the same refrain on 401(k) contribution rates -- steer enough of your paycheck as possible to your 401(k) plan without causing any upheaval with your personal finances.

Call it the 401(k) sweet spot, and it's easier to find than you might think, if you have a good plan.

"There are several factors that go into determining an individual's 401(k) contribution rate, including the age of the contributor, his/her income and expenses, whether or not the company matches and to what extent, and any outside investments, just to name a few," says Mike Zaino, CEO of TZG Financial in Charlotte, North Carolina.

First off, the age of the 401(k) contributor plays a significant role, Zaino says. "Younger participants traditionally earn less than tenured participants and therefore cannot afford to contribute as much -- or at least that's what conventional wisdom would dictate," he says. "On the contrary, tenured participants, although they presumably earn more, also tend to have more expenses such as larger homes, more expensive cars and children's college tuition, among others."

Other retirement experts say there really is no hard and fast magic number -- it all depends on myriad moving financial parts that impact 401(k) savers.

"For instance, if you have a lot of outstanding high-interest rate debt, like credit card debt, you might be best pulling back your 401(k) contributions and paying off your debt," says Jamie Hopkins, director of the retirement income program at The American College of Financial Services, in Bryn Mawr, Pennsylvania.

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There is, however, a minimal threshold to clear. "Almost everyone should contribute enough of their salary to get the full employer match, if offered," Hopkins says. "That can range from 3 to 6 percent of your salary for most employers. However, you should not stop at the match. Most people need to be saving closer to 10 percent (or more) a year to be financially secure in retirement."

Much also depends on how much you plan to live on in retirement.

"Let's say that you want to replace 50 percent of your salary in retirement," Hopkins says. "If you save for 30 years and have a retirement period of 30 years, you'll need to save about 15 to 16 percent of your income each year. However, if you are willing to save for 40 years, the safe savings rate can drop closer to 7 to 9 percent of your income. So if you are age 30, hopefully you have been saving close to 10 percent of you income each year and if you keep that up until age 65, you should be in good shape to retire."

Procrastination plays a big role, too. "The longer you wait to start saving, the more you'll have to save each year," Hopkins says. "For instance, if you want to replace 50 percent of your income in retirement from your savings and only have 20 years to save for a 30-year retirement, you'll have to be saving over 30 percent of your income a year to meet your goals."

If there has to be a specific contribution rate number in place for 401(k) savers, aim higher rather than lower, retirement experts say.

"The best contribution rate is 15 percent," says Trisha Brambley, CEO of Retirement Playbook in Philadelphia, a provider of retirement plan services for employers.

Brambley says this can be achieved through a combination of deferrals, employer match and any other company contributions. "This number is generally expected to produce enough income at retirement to sustain individuals through the duration of their life," she says. "However, some people will intentionally save less because their spouse has a great plan or they have money outside of retirement assets or they have an ample defined benefit plan (like a company pension)."

In addition, there are other rules provide a general idea of how much you need: in your 401(k) fund. "Aim for 10 times your annual salary as your nest egg and draw down about 4 percent per year in retirement," Brambley says. "These rules are not carved in stone. Employees really need to use their record keepers' retirement calculator and figure it out, but these numbers can be a wake-up call for employees."

Your best 401(k) retirement contribution rate strategy? Brambley advises something short and sweet.

"Pick a date -- your birthday, for example -- to spend one half hour every year checking on your 401(k) plan, including your contribution rates, but also your beneficiary designation, asset allocation, deferral rates, and goals," she says. "You can do that while you're standing in line at Starbucks."

[See: 9 Psychological Biases That Hurt Investors.]

It could be that easy to find your 401(k) retirement contribution rate sweet spot. And once you get it, keep committing to that each year at bare minimum. Do that, and your golden years will sweet, indeed.



Brian O'Connell is a contributing financial writer for U.S. News & World Report. A former Wall Street bond trader and the author of two best-selling books; "The 401k Millionaire" and "CNBC's Creating Wealth", he has 20 years experience covering business news and trends, particularly in the financial, technology, political and career management sectors. His byline has appeared in dozens of top-tier national business publications, including CBS News, Bloomberg, Time, MSN Money, The Wall Street Journal, CNBC, TheStreet.com, Yahoo Finance, CBS Marketwatch, and many more. Visit his web site at: https://brianoco.contently.com/. Or, visit this Amazon.com link for a list/review of some of his book titles. Reach out to him on LinkedIn.