How to Calculate the Percentage to Contribute to a 401K
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.
Top Contribution Method: Max Your 401k Percentage
If you want maximum funding for your 401k plan, then determining the contribution percentage is straightforward, even without a 401k max contribution calculator. The maximum contribution per year is age based and changes depending on whether you're age 50 and over, or whether you're under the age of 50, as set forth below. To calculate the correct percentage to contribute, divide the annual 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.
Maximize Employer 401k Matching
If you can't afford to contribute the maximum amount, another 401k strategy is to contribute at least up to your employer's contribution matching percentage. Most employers match a percentage of contributions ranging from 1 percent to 6 percent. For example, your employer might offer a match 100 percent of your contributions up to 5 percent. Therefore, if you contributed 5 percent per paycheck to the 401k plan, you would receive the maximum matching contribution from the employer, and your employer would contribute another 5 percent to your retirement plan. You can use a 401k match calculator to determine what the total contribution would be from all sources, as some employers take a more complex approach and only contribute a percentage of a percentage, or a flat dollar amount.
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.
2017 and 2018 401k Contribution Limits
In the 2017 tax year, the contribution limit per year per person was $18,000, meaning you could not contribute more than that total in the year 2017 to your 401k. The figure went up to $18,500 for 2018, and it may increase again in the future to account for inflation.
For example, if you make $200,000 per year and contribute 10 percent of each paycheck's pretax dollars, you'll be over the limit, as your contributions would reach $20,000 for the year. Your plan will stop taking contributions after you reach $18,500. However, if you turned 50 during the calendar year or you are over 50, you may be able to make additional contributions depending upon the type of 401k plan and how much you've already contributed. These "catch up" contributions are $6,000 for traditional and safe harbor 401k plans or $3,000 for SIMPLE 401k plans.
Importantly, your 401k contribution limit only applies to your contributions, not to your employer's matching contributions. If you contribute the max $18,500 from your pay in 2018, your employer's additional contributions are still permitted.
Kevin O'Flynn began writing in 2008 with a background in private equity. He has written for MilitarySpot.com and lived and worked in the United Kingdom and Japan. O'Flynn holds a Master of Business Administration from Case Western Reserve University.