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A 401k is a good way to build tax deferred wealth, but deciding what amount to contribute is challenging. The amount to withhold from each paycheck might depend on a number of factors, including your age, income and financial needs, as well as whether your employee offers matching contributions. It is important to follow a few basic guidelines to determine how to calculate the percentage you should contribute.
If an investor wants to put the maximum level of funding in a 401k plan, then determining the contribution percentage is straightforward. The maximum contribution per year is age based: $17,000 for those under age 50, and $22,500 for those 50 and older. To calculate the correct percentage to contribute, divide the limit by the number of total yearly paychecks. The result should then be divided by your gross salary per paycheck to learn the contribution percentage.
For employees who can't the maximum amount, another 401k strategy is to contribute at least up to the firm's contribution matching percentage. Most employers match a percentage of contributions ranging from 1 percent to 6 percent. For example, a firm might offer a 25 percent match on the first 5 percent of contributions. Therefore, an employee that contributed 5 percent per paycheck to the 401k plan would received the maximum matching contribution from the employer.
A different 401k strategy is to begin contributing 1 percent of your salary and slowly adjust the contribution level up over time. This gradual approach helps you avoid budget shocks stemming from suddenly lower cash flow. Eventually you can ratchet up the 401k percentage contribution when salary levels climb.
If you prefer to keep your take-home pay pretty consistent from year to year, you can simply pick a percentage that works for you and maintain it. This keeps your paycheck contribution steady. Dollar-wise, a little more money will go into your 401k plan every year if you earn annual raises and bonuses.