What is the optimal amount to contribute to your 401(k) plan?

There are many types of retirement accounts out there, but the 401(k) may just be the most convenient.

An employer-sponsored 401(k) plan allows you to automatically contribute to your account from each paycheck, invest in professionally-vetted funds, and, in most cases, put off income tax on that income until later in life.

Many employers have a matching contribution to 401(k)s as an employee benefit – as long as you put in some cash yourself. But how much should you put in, and what can you do to get the most from your 401(k) in the long haul? Here’s what you need to know.

Find your retirement savings plan How much can you contribute to your 401(k)?

The Internal Revenue Service sets the contribution limit for 401(k)s annually. This limit varies based on your age, but for 2022, most Americans can contribute up to $20,500 across the entire year. If you’re 50 or older, the limit goes up to $27,000 (this allows workers nearing retirement a catch up contribution).

That is just your personal contribution limit, though. You can technically exceed these amounts – up to 100% of your compensation or $61,000, whichever is lower – if your employer also contributes to the account. Some employers offer a matching contribution, meaning for each dollar you contribute to your account, they’ll contribute a matching amount up to a certain threshold.

According to a report from investment management group Vanguard, most employers with matching benefits will contribute 50 cents on the dollar for up to 6% of the employee’s pay. So if you made $50,000, your employer would contribute up to $1,500 per year, provided you contributed at least $3,000 yourself (50,000 x .06).

How do your retirement savings stack up? How much should you contribute?

Ideally, you’d take advantage of the IRS maximum contribution limit to your account year after year. But if that’s not possible financially, start by contributing enough to max out your employer contribution. If you’re not sure what that is, check with your company’s benefits administrator. They can walk you through the matching contribution policy and direct you on how to set up contributions.

Story continues

“Contribute the maximum your household budget will allow, up to the maximum annual contributions allowed by the IRS,” says Daniel Milan, managing partner at Cornerstone Financial Services. “At the very least, if your company offers a match, you should contribute at least the percentage required to get the maximum match, as that is free money you’re leaving on the table if you don’t.”

Pay attention, though. Your company may change its matching policy from time to time, so make sure to check in annually with your plan administrator. You’ll want to take full advantage of any employer contributions as long as it’s financially possible.

401(k) alternatives

If you’re able to max out your (and your employer’s) 401(k) contributions and still have disposable funds leftover, you might want to consider contributing to other accounts in addition to your 401(k).

Some options include:

IRAs: Both traditional and Roth IRAs can be smart options. These allow you to contribute up to $6,000 annually (more if you’re 50 or older) and build wealth for retirement. The difference between the two lies in their tax treatment. With traditional IRAs, you pay taxes upon withdrawal, while Roth IRA contributions are post-tax, meaning you pay taxes on the income first and then make the contribution. This allows you to avoid taxes when you withdraw funds later on.

Health Savings Accounts: With an HSA, you can set aside pre-tax money to use toward health care costs – including things like medications, first aid supplies, health insurance deductibles, and other health-related expenses you might incur (like Covid tests, for example).

Life insurance: If you have a spouse or dependents, putting extra funds toward a life insurance policy could be financially wise. Make sure to talk to an insurance agent if you opt for this strategy, as there are several types of policies to think about.

529 plans: A 529 plan lets you build up funds for your child’s future college costs. Some plans even let your child use the money for trade school and other expenses once they reach a certain age. (This varies by state, though, so check with a financial professional in your area).

You can also talk to a financial advisor, who can help you determine the best strategy for your budget and retirement goals. They can provide investment, saving, and budgeting guidance personalized to your specific situation.