The 401(k) Series #6: What is the right deferral rate for your 401(k)?
When you’re laying the foundation for your retirement, the first big step is choosing your deferral rate. When you say it that way, it seems easy. What if I said, “how much of your paycheck will you sacrifice now for your future self?”
Your 401(k) contribution rate will set the financial tone for your retirement plan. First let’s start with the factors that go into this determination:
- Age of the Contributor – younger participants traditionally have a lower salary to work with
- Income – 3% of 100,000 is significantly higher than 3% of 40,000
- Expenses – while it seems natural to calculate your contribution rate after everything else is paid, we advise our clients to adjust your expenses to allow for the optimal deferral rate. Pay Yourself First!!
- Company Match – does your company offer a matching contribution?
- Outside investments – are you investing for retirement elsewhere?
It’s clear that savers are at different points in their careers and lives. There is not a magic number. But everyone can take steps to get to the optimal amount of savings. There are many factors that can help you determine your deferral rate. This checklist is a good place to start:
- You have to start somewhere. Make that first step. SIGN UP! Even if it’s a small deferral, get in the habit of doing something
- Start with a calculation of how much you will need. Refer to #3 in this series “On my retirement day, how much money will I need”
- If possible, maximize the company match. If your company offers a match, ideally you would be able to save enough to get the full match…the FREE MONEY!
- Next, focus on paying off your high interest debt like credit cards.
- Make a goal to increase your contribution every year until you reach 15% – traditionally known as the 401(k) deferral Sweet Spot.
Conclusion: Make a commitment to pay yourself first and take advantage of free money from your employer. Stay disciplined and work toward a goal of increasing your deferral every year. When selecting a deferral rate, aim higher rather than lower! You’ll thank yourself later! If this process seems overwhelming, a financial advisor can help you determine the best rate for your situation.