Retirement plan decisions made easy
Drill Down: The Gradual Option for Building a 401k
The best choice for most people is to fund their 401k both fully and immediately. That’s easy for me to say—I’m not going to have to cut back my spending, so what should I care about your current hardships? But I think this is good advice for almost everyone, because after you adjust to less take-home pay, you won’t really feel the bite. You will, however, be building up a retirement nest egg.
But let’s say that you’ve reviewed your family budget and you just cannot find enough expenses to cut to enable a full contribution. Here’s my suggestion. Start with whatever you can manage today. Then, every pay raise you get, put the full amount of the raise into your 401k plan. You won’t have to cut back on current expenses, but you will gradually increase the pace at which you contribute to your 401k.
As of this writing, wage increases in the average job are running over three percent per year. That does not include promotions that trigger pay raises. Pretty soon you could be up to six percent contribution of your pay.
Here’s a numerical example. (If you don’t like numbers, just skip the rest of this section.) Assume the marginal tax bracket is 25 percent, and the 401k goal is six percent. Monthly salary is $3,000, but will rise by three percent per year. Right now you can only afford to contribute $30 a month into your 401k.
In year two, you get a three percent raise, which equals $90 a month. You put it all into your 401k, bringing your monthly contribution up to $120. That’s a lot better than where you started, but still not up to your goal. In year three, you get another three percent raise, which now is worth an additional $93 a month on top of the first $90. You only need to add $71 of that raise to your 401k contribution to get up to your goal of six percent contributions. You keep the rest. It’s not real easy to go a couple of years without a raise, but it will get your retirement savings on track.
For anyone, there is a way to get your 401k contribution up to the level that will provide for your retirement.
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Lesson 1: What the Heck is a 401k, and What’s So Great About It?
» Lesson 2: Contributions to Your 401k
Lesson 3: Investments “Cook Book” Approach
Lesson 4: Investments: How Investments Work
Lesson 5: Loans and Hardship Withdrawals from Your 401k
Lesson 9: Your 401k, Your Other Assets, and Your Life
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