How much you contribute to a 401k plan is up to you, within guidelines established by the IRS. A 401k plan is an investment program or retirement plan that allows you to contribute pre-tax dollars into an employer-sponsored account. You choose the amount to be deducted from each paycheck -- your employer also may contribute. The amount you contribute depends on numerous factors, such as your salary or wages, family considerations, age, length to retirement and other existing retirement options, like a pension.
Types of 401k Plans
The IRS designates three types of 401k plans -- Traditional, Safe Harbor and SIMPLE. Each plan is employer-sponsored. Traditional 401ks require employers to meet certain non- discrimination requirements that are designed, among other reasons, to ensure that employer matching contributions don’t discriminate in favor of high-paid workers. Safe harbor and SIMPLE plans don’t contain non-discrimination clauses. Traditional plans may or may not offer immediate vesting of your deferred funds -- contributions -- while the other plans require your contributions to be fully vested immediately. Employer contributions can be any percentage of your contribution.
The amount you contribute to a 401k plan is a very personal matter. If you’re young, you may not be in a position to contribute maximum allowable amounts, while older adults not only may be able to contribute maximum amounts but might find it necessary to do so if they haven’t been contributing to a retirement fund over the years. How much you contribute also depends on the amount of matching funds provided by your employer. The more your employer contributes, the less you may have to defer. One rule of thumb is to contribute enough to ensure that you’re maximizing your employer contribution.
A common employer-contribution level is 6 percent of your salary, according to the website “Money Under 30.” By not contributing at least enough to maximize the employer contribution, you’re basically refusing money. If you’re under 30, the site recommends a graduated contribution scale based on employer contributions. With no employer contribution, a minimum 5 percent employee contribution is suggested. If your employer contributes, you should at least match the figure. If your employer contributes an amount that equals at least $5,000 annually, you should contribute the same percentage plus open a Roth IRA and match the Roth 2010 $5,000 contribution limit. Higher percentages of employer contributions should be matched or exceeded and Roth IRAs maxed out as you earn more money.
If you begin contributing at age 22, you should have a goal at 30 of having a 401k fund equal to your yearly salary. Older people may have to contribute larger amounts to keep pace with salary levels, or even utilize the “catch-up” provision after age 50, which allows additional 401k contributions.
If your employer doesn’t match employee contributions on a 100 percent basis, you need to do a bit of math to capture the maximum employer contribution. For example, if your employer matches 100 percent of your contributions up to 6 percent, you need to contribute 6 percent to maximize employer contributions. If your employer matches only 50 percent of your contributions up to 6 percent, you must contribute 12 percent of your paycheck to capture the full employer contribution. Many online sites, including Bloomberg, provide 401k savings calculators that take into account most relevant factors.
IRS 401(k) annual contribution limits as of the time of publication are $16,500 for Traditional and Safe Harbor plans and $11,500 for SIMPLE programs. Catch-up limits are $5,500 for Traditional and Safe Harbor plans and $2,500 for SIMPLE plans. So, if you’re over 50, the maximum yearly contribution in a Traditional plan would be $22,000 - $16,500 + $5,500 = $22,000.