How Much Should I Contribute to My 401(k)?

How to make the most of your retirement savings options.

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Roger Wohlner

In a recent Facebook thread among a group of fellow financial bloggers, one young lady recently asked, “What's a good starting percentage for my first 401(k)? Three percent? Five percent? More?” She is 22. Kudos to her for asking such a great question; this is not the thought process of all 22-year-olds, something I could relate to as the father of a financially savvy 24-year-old daughter who is more than two years out of college.

My daughter is fortunate in that she works for her alma mater, a major university with a fantastic defined-contribution plan. She contributes an amount which gets her the maximum match, which is substantial. She is off to a great start on her retirement savings journey.

In the case of the woman who asked the question, I suggested that she contribute at least enough to receive her company’s maximum match which from what she described indicated that the plan might be a Safe Harbor plan. What this means is that her employer matches her contributions 100 percent on the first 4 percent of salary deferred and 50 percent on the next two percentage points of salary deferred meaning that if she contributes 6 percent of salary the company will have matched another 5 percent of her salary. Further, if this is indeed a Safe Harbor plan, she will be immediately vested (meaning she immediately owns) in these matching contributions. In a non-Safe Harbor situation vesting might happen over a five-year period, meaning that if you leave the company before becoming fully vested you lose some of the matching contributions.

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I also suggested to her that if she could not afford to defer the full 6 percent right away that she contribute as much as possible and plan to increase her deferral percentage each year, perhaps around the time of any salary increase. Some plans even offer an auto increase feature to help employers increase their saving percentage each year.

But what about using the 401(k) as your only retirement savings option? I've heard the concerns about saving in a 401(k) at all due to a fear of rumored changes in the government’s rules, along with articles suggesting multi-pronged strategies that might include contributing to the 401(k) up to a point in combination with various other strategies such as the Roth IRA.

The government may change the rules at some point, but as with any aspect of financial planning it is wise to base you’re planning on the rules in place today, but better to keep it simple. Among the benefits of a 401(k) is its simplicity. You defer a portion of your salary, it's automatic each pay period, and you likely will never miss it. Quite often, the more complex you try to make things, the less likely you are to follow through over time. Let’s face it: life throws enough at us, anything that can be kept easy and relatively painless is a plus.

The 401(k) (and similar defined-contribution retirement plans) has gotten an excessively bad rap in recent years between losses during the financial crises and the recent light shed on the high fees and poor investment choices offered by some plans. To be sure, there are some lousy 401(k) plans out there.

But among my clients, many have been able to accumulate sizable nest eggs in their 401(k) plans during their working lives. These balances comprise a significant portion of what is (or will be) a comfortable stream of retirement income. Based on inquires I receive from prospective clients (and subsequent research) seven-figure 401(k) balances are not uncommon. What’s their secret? Consistent deferrals over their working career and a rational investment strategy are a common thread.

While there is no guarantee of what the future may hold, my best suggestion to retirement savers at any stage of their career (but especially to younger investors) is to save as much as is feasible in your 401(k) or similar plan and invest in line with a financial plan before venturing off into other areas.

Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides financial planning and investment advice to individual clients, 401(k) plan sponsors and participants, foundations, and endowments. Roger is active on both Twitter (@rwohlner) and LinkedIn. Check out Roger's popular blog The Chicago Financial Planner where he writes about issues concerning financial planning, investments, and retirement plans.