Should I Max Out My 401(k)? And Other Retirement Planning Questions

Money, Saving, Savings, Finance, Economy, Accounting

What is a 401(k) and why should I start saving?

For many people, retirement may seem like a distant dream. 

However, it is critical to begin planning for your financial needs and thinking about the future now. The sooner you start saving, the more options you have for how much money you can save each month or year.

But what should you save for? How much do you need to retire comfortably? What if I can’t afford to contribute 12% of my income every year? Should I max out my 401(k)? 

These are just some of the questions you might have when you think about your financial future. If you’re not sure where to begin on your retirement planning journey, this guide will provide a framework that will help you plan for your retirement.

What is retirement planning? 

Retirement planning is the process of deciding how much to save for retirement, where to invest your savings, and when to begin saving. 

It’s a lifelong goal that involves many different stages in life, such as deciding what type of work environment is best for you, putting money aside each month (or year), researching and investing your money, and eventually retiring.

Many people have questions about retirement planning, such as:

  • What is the best way to save for retirement? 
  • Should I max out my 401(k)? 
  • How much should I start saving at age 25 vs. 35 vs. 45? 

These are all valid questions to consider as you plan your financial future

It’s easy to become overwhelmed when you start thinking about retirement. But don’t worry: it’s never too early to begin saving, and by starting now, you’ll have more options for reaching your retirement goal.

What is a 401(k)?

A 401(k) is an investment vehicle offered by an employer (not technically a type of account). 

Retirement plans, such as 401(k)s, allow you to save for retirement while also lowering your taxable income through tax-deferred growth.

Below are the 15 most common questions people ask themselves when they think about their financial future:

When should I start saving for retirement? 

You will need to save a different percentage of your income depending on your age and earning potential. 

For example, if you’re 25 years old, have no dependents, and make $40,000 per year (before taxes), it’s recommended that you contribute $50-$100 per month to your 401(k) (or any other retirement plan).

What is the best way to save? 

In general, you should begin saving for retirement before paying off debt or making a large purchase. 

However, there is no one-size-fits-all answer to this question––it is dependent on your financial situation and what is most important to you at the time. 

For example, if you have significant credit card debt with interest, it is recommended that you pay it off before beginning to save for retirement. However, if you are debt-free and can afford to set money aside each month, both are excellent ways to lay the groundwork for a thriving financial future.

What if I can’t afford to contribute? 

Just because you can’t afford to set aside a large portion of your income for retirement savings doesn’t mean it’s not the best option for you. 

Saving $150 per month in your twenties, for example, may appear to be an impossible goal, especially when you have so many other expenses coming up, such as rent, travel, and an emergency fund.

However, suppose you can manage to save even $50 per month toward your retirement goal as a young adult (while also continuing to build up your emergency fund). In that case, it’s still worthwhile to put in the effort—and those small contributions will add up over time.

What is the average savings rate? 

A successful retirement is defined as saving an average of 12% or more per year for at least 40 years.

However, this does not imply that you should save 12% of your annual income for the rest of your life. Rather, it is recommended that you save more when you are younger and can afford it. Whatever percentage you save consistently over time will add up—and compound interest is your friend.

How does compound interest work?

Compound interest occurs when the earnings on your investment, in addition to any initial funds invested, are reinvested in order for them to grow. 

This will allow you to earn more money over time, increasing the size of your return—which means bigger returns for you.

401(k) Contributions 'Crowded Out' by HSAs—Does It Matter?

What are the benefits of maxing out my 401(k)? 

If you maximize your contributions to a Roth or Traditional 401(k), you will save for retirement and receive tax benefits. 

You can contribute up to $19,000 per year to your 401(k) (or $26,000 if you are 50 or older). And once you retire and start withdrawing money from your account, you won’t have to pay taxes on it again.

What is a Roth IRA? 

A Roth IRA is a type of retirement account that allows you to save for the future tax-free. 

As long as your income is within certain limits, you can contribute up to $5500 per year (or $6500 if you are 50 or older) to a Roth IRA, and any money withdrawn from this account will not be taxed in the future.

What is a Traditional IRA? 

A traditional IRA allows you to save for retirement while also receiving tax breaks in the present. If your income falls within certain limits, you can deduct up to $5500 per year (or $6500 if you are 50 or older) from your taxable income when making contributions.

What are the benefits of maxing out my IRA? 

Contributions to an IRA allow you to reduce your taxable income while saving for retirement tax-free—and there is no annual contribution limit (as long as you meet certain requirements). 

For example, suppose your annual salary is $80K, and your spouse’s salary is $40K. In that case, you could contribute up to $14000 per year (100% of the allowed contribution) into a Traditional IRA for a couple between the ages of 50 and 70—and still receive tax benefits on those contributions now.

Should I max out my 401(k)?

It’s usually never a bad idea to contribute as much as you can afford to your retirement.

Still, there are many factors to consider, such as how long until you retire, the type of lifestyle you want in the future (for example, traveling every year or owning a home), and any other financial goals that are important to you. 

For example, if you intend to buy a home in the coming years and hope to contribute to your down payment savings account each year, it may not be sensible to put all of your money into retirement when you have other financial goals that require attention.

What should I save for?

While retirement is an important goal, you will likely also want to save for any other financial goals you may have (i.e., buying a house or starting your own business). If these are long-term goals with high costs, saving now will pay off later and help you reduce some of those expenses by having money available.

What type of company should I work for to maximize my earnings potential and minimize my risk of unemployment in the long run?

Not all companies are created equal, and your long-term earnings outlook may vary depending on where you work. 

When choosing the right company for you, there is a lot to think about, including their culture, location (some jobs pay better if they’re inexpensive cities), benefits package, paid time off policy, average raise percentage each year, etc. 

To choose the right company for you, be sure to do your research and read reviews from current employees—plus ask around with friends or family members who may have experience working in the industry.

Why am I not earning as much money as my friends or family members who are the same age as me?

It’s never fun to admit that you make less money than your friends or family members, especially if they’re around your age. 

Every person has their own set of skills and experiences, so while one person may be paid more than another for no discernible reason (i.e., simply by chance), some people may be paid more because they are better at negotiating their salary or have a degree that is in high demand.

People are often also not earning as much money because they haven’t found the right company to work for or are dissatisfied with their current employment situation. It may be time to consider other options, but if you’re content where you are, you may want to look for ways to increase your salary (e.g., negotiating for a raise or asking for other perks that may help you).

How much do you need to retire comfortably?

It’s never easy to answer this question because your retirement needs are different from the next person’s—and everyone has a different definition of what it means to be financially comfortable. 

To figure out how much you’ll need, consider whether it’s financially feasible for you to live solely on social security (if that’s an option), and make sure to factor in any other sources of income you may have (e.g., a pension plan). 

If it turns out that you’ll need even more money to support your desired lifestyle, make sure to save enough money each month to have a buffer in case something unexpected happens, or inflation rises dramatically over time.

Will I run out of money in retirement?

People are living longer than ever before, so it’s unlikely that you’ll run out of money in retirement—having enough saved for your golden years is preferable to not being prepared at all. 

However, if the rate at which inflation rises each year exceeds the return on your investments, it can be challenging to maintain a comfortable lifestyle. Consider investing in low-cost index funds and other investment products that offer the potential for growth without charging a significant fee to mitigate this risk.

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