How much to contribute to 401k?

  • April 26, 2019
  • 401k
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How much to contribute to 401k

401k plans have firmly established themselves as a mainstay in the private pension system in the United States. Initially, made law in the Revenue Act of 1978, 401k plans have grown substantially. This is because of company matches, tax deferrals, and payroll deduction features encouraging employee participation. Though some employees choose to evade 401k plans due to financial constraints. Others don’t have extra money to save and plan to rely on late employment for income in retirement. Accounting for almost one out of every three dollars held in employer-sponsored pension funds. We can ask, ‘how much to contribute to 401k?’

Contribution Trends

Generally, studies show that most employees contribute less than the legal maximum in 401k plans. In retrospect, federal income tax law limits contributions to 401k pension plans in three main ways. Firstly, in terms of an annual dollar limit on the amount an employee can contribute to a 401k plan. Secondly, with an annual dollar limit on the combined amount that both employer and employee can contribute. Lastly, with the percentage-of-compensation limits on combined employer and employee 401k contributions.

Contribution limits.

Since we are discussing “how much to contribute to 401k?”, mentioning contribution limits is inevitable. Specifically, the contribution limit for 2018 was $18,500 in elective deferrals, or $24,500 for employees 50+ years. Furthermore, for the 2019 tax year, that limit is $19,000, or $25,000 for individuals 50 years and above. Additionally, total contributions which combine both an employee and employer couldn’t exceed $55,000 in 2018. And $61,000 for individuals 50 years and up. Similarly, in 2019, those contribution limits will be $56,000 and $62,000 for individuals 50 years plus.

Employer contributions

Generally, employers usually contribute a constant percentage of wages as a 401k matching contribution for all participating employees. In contrast, in other plans the employer contribution amount varies with the employee’s own contribution. Additionally, there are non-discrimination rules in the tax law that require broad participation of employees. Especially at different wage levels for 401k plans qualification for tax deferral. Ideally, the non-discrimination rules incentivize employers to subsidize participation by low-wage workers. This is mainly because without broad participation their 401k plans would not qualify. Additionally, business owners and their high-wage employees wouldn’t take advantage of the tax benefits.

Matching Options

Since we already got on the boat of ‘how much to contribute to 401k’, we need to discuss employer matching. Employer matching affects how much employees choose to contribute in most cases. While many matching contribution variations exist, there are certain match levels customary for companies in similar industries or geographic region. Specifically, organizations may also choose use of discretionary contributions as a performance-based, pre-tax bonus. Furthermore, these bonuses may be based on factors such as: achieving defined individual or departmental goals. So, what have four matching options?

  • Fixed match: Here an employer contributes $1 for every $1 the employee defers to the 401k plan. This is up to a defined contribution ceiling for example, 6% of pay.
  • Percentage match: In this variation, an employer contributes a percentage of the
    salary an employee defers into the 401k account.
  • Blanket contribution: in this instance, an employer makes a blanket percentage contribution for all employees. This is regardless of whether they defer pay into the 401k plan.
  • Multi-tier formula: Finally, here an employer’s contributions decrease as the employee’s deferment increases. Though, the most common match today is dollar-for-dollar on the first 6% of the employee deferrals.

Contributions Determinants

I believe some determinants play a role in the limits of individual 401k contributions. These determinants could be age, gender, education, job tenure, saving culture, income, and planning horizon. For example, it’s been shown that the importance of age reflects in part life-cycle patterns of 401k saving. Furthermore, it’s been proven that individuals will save more towards the latter end of their working careers. Especially, when their earnings are typically higher relative to their living expenses. Additionally, older employees toward the end of their working life are more aware of saving for retirement than young workers.

Gender factors

In retrospect, more men than women participate and contribute to 401k plans. This could be justified by women earning less than men on average. Or maybe women being more likely to work in jobs that do not offer pension benefits like part-time positions or positions in small firms. Furthermore, job tenure and job security have a positive and significant effect on 401k contribution rates. For instance, compared to less educated workers, higher educated employees are generally more aware of the need for saving. They are more knowledgeable about the advantages of 401k plans and how to fully use them.

Income Factor

Its noteworthy, that contribution rates typically rise with one’s income. Specifically, higher earners are less financially constrained than low earners. Hence, can put away larger portions of their income into retirement savings. Though, employee contributions are typically limited by statutory and plan-specific amounts. Additionally, 401k participants tend to automatically contribute at plan-specific limits. These limits could be the default rate, the match threshold, and the maximum contribution limit. Furthermore, both loan provisions and investment choice can increase contributions to 401k plans.

Conclusion

In discussing, how much to contribute to 401k, I’m a firm believer in contributing up to the maximum. The Indians believe it’s good to save for a ‘rainy’ day. Especially since it ‘rains’ daily in India. Furthermore, we have seen that contributing the maximum amount is higher among some income and demographic groups than others. Additionally, maximum contributors are more common among higher educated employees at times. All in all, when considering how much to contribute to 401k, aim for the maximum if you can. You can always get a loan against your 401k or worst case, a hardship withdrawal!

Executive Assistant and Content designer at T3 Direct LLC I have tailored my skills in all verticals of marketing & business development. I have mastered a niche in Lead Generation, Digital Marketing, organize/develop projects, team development, data analysis, & excellent customer service.

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