The Contribution Challenge
Figuring out how much you should contribute to your retirement can be challenging. Because there are so many different plans with a lot of different rules. You have 401(k)s, 403(b)s, Profit Sharing Plans and the list goes on. The question that stays the same is, “how much you need to save for your retirement?”
There are a few things to consider and mistakes to avoid.
The Retirement Plan Auto-Enrollment
Many plans have great features such as auto-enroll and matching contributions. They’re features that help and encourage you to save.
The auto-enroll means that if you do nothing, you will be automatically enrolled in your employer’s plan. This doesn’t actually mean you should do nothing. It’s not going to figure out your retirement for you or how much you need to save.
The Pre-Tax Incentive
The majority of retirement plans are pre-tax and may reduce your overall tax liability in the year you make the contributions. Each dollar that you contribute can have a significant impact on your savings depending on your tax bracket. The more money you make, the more each dollar contributed will help reduce your tax liability.
The Benefit of Retirement Planning
Saving the default contribution amounts can be a bit misleading. You might be thinking if you’re saving the default amount that you should be on track to have a happy and healthy retirement, right? Unfortunately, the 3-4% that saved into your retirement plan at work may not be enough to fund your retirement. After all, the default contribution does not take into consideration your retirement goals.
There is still hope because you’re on the path to retirement, but it may just need a little adjusting. It’s great that employers have an auto-enroll feature in their plans. Otherwise, you may have just forgot to start that plan. It’s also a little scary at the same time because unless your plan has the auto-enroll feature, we may not have started saving in the first place.
Calculating Your Savings in Today’s Dollars
Now, you may be wondering if you’re saving enough, so let’s take a look at some numbers to put things into perspective. Consider a salary of $60,000 per year for 30 years with a contribution of 3% into a 401(k). If that amount is invested at an 8% rate of return, it will result in approximately $225,000. To account for your employer’s 3% matching contributions, we’ll double that to $450,000.
At first, you might be thinking, “that’s pretty good if I had 450,000 I might retire tomorrow.” Not so fast, we’ll have to account for what $450,000 can buy you in 30 years. Putting this into perspective, that would be $183,000 in today’s dollars. If you project your retirement savings to be 80% of your current income, that would be $48,000 annually in retirement. Again, in today’s dollars, that’s only 3.8 years that you have saved for your retirement at the default 3% savings rate.
The Full Retirement Planning Picture
There may be other sources of income such as social security, a pension, inheritance or part time work.
The more you save, the better off you’re going to be in retirement. However, it’s not just about saving more; it’s about making sure you’re saving enough.
You don’t have to shy away from setting a goal just because you’re not sure what you completely want in retirement. It can change as often as you change your mind, just get a goal so you can start figuring out how much is reasonable and necessary to save.