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How Much Should I Contribute to a 401(k)?

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Lee Huffman
Updated November 3, 2022
6 Min Read

Contributing to a 401(k) is one of the easiest and best ways to save for retirement. Eligible workers can have contributions automatically withdrawn from their paychecks, so they don't have to remember to invest. The money grows tax-deferred until retirement, and you can take it with you when you leave your job. Here's how much you should contribute to a 401(k) to reach your retirement goals.

How much can you contribute to a 401(k)?

Because company retirement accounts like 401(k), 403(b), and 457 Plans are so powerful, the Federal government limits how much you can save in them each year. For most workers, the annual 401(k) contribution limit is $20,500 in 2022. For 2023, the contribution limit is increasing to $22,500.

Catch-up provision for 50 and older

Many older workers are behind on their retirement savings. To address this issue, workers that are 50 years and older can make "catch-up contributions" above and beyond the normal contribution limits.

In 2022, eligible workers can contribute an extra $6,500, for a total 401(k) contribution maximum of $27,000. This catch-up contribution maximum increases to $7,500 in 2023, which results in an annual contribution limit of $30,000.

Highly compensated employees

If you are considered a "highly compensated employee" (HCE) within your company, your contribution limit may be lower. This rule applies to employees that own more than 5% of the company's stock or who will make at least $135,000 in 2022. Employers can also designate the top 20% of earners within the company as HCEs.

Based on testing of all 401(k) participants, HCEs may have limits placed on matching contributions received from employers. Additionally, there may be an absolute limit placed on the total contributions made to their retirement account (company and individual contributions combined). Workers who qualify as HCEs should speak with their Human Resources department and financial advisor to discuss how this impacts their maximum contribution limits.

Self-employed 401(k)

Self-employed individuals have a unique opportunity to save for retirement. When you have a one-person company, you can create a "solo 401(k)" that enables you to save far more than the normal 401(k) contribution limits.

The contributions are broken into two parts – individual contributions (2022: $20,500 standard, $27,000 for 50 and older) and employer non-elective contributions. The employer contribution can be up to 25% of your compensation or earned income for the year. Combined, you can add up to $61,000 to your solo 401(k) in 2022. Plus, you can save even more with catch-up contributions.

Qualify for employer matching contributions

Most larger and many smaller companies offer employer matching contributions when participating in the company's retirement plan. However, the rules regarding matching contributions may vary widely depending on which company you work for.

  • Vesting period. Companies often vest matching contributions over several years to encourage employees to stay in their job longer. For example, your matching contributions may vest 20% per year of employment. After five years, you are 100% vested. However, if you leave after three years, you'll forfeit 40% of the company's matching contribution.
  • Eligibility period. Some companies do not allow new employees to participate in the company's 401(k) until they've worked long enough. In many cases, you can start contributing after you've passed the 90-day probationary period.
  • How they're invested. Companies may designate that matching contributions go to a particular investment. Sometimes, you can move the money into another investment immediately. In other cases, companies require that you hold the investment for a period of time.
  • Per paycheck rule. Workers can contribute to their 401(k) on any schedule that they like. You can max it out quickly or spread out contributions throughout the year. Most employers provide matching contributions on a per-paycheck basis. This means that if you max out your 401(k) early, you'll miss out on matching contributions later in the year.

What are your retirement goals?

When determining how much you can contribute to a 401(k), it helps to align those contributions to your retirement goals. While you can contribute to the maximum allowed every year, that may not align with your goals for retirement.

  • Early retirement. For investors who want to retire early, investing in taxable brokerage accounts can make more sense. You can withdraw from these brokerage accounts without worrying about early withdrawal rules or penalties. And you have greater flexibility in where you can invest your money.
  • Traditional vs. Roth 401(k). Many companies now offer Roth 401(k) accounts. Contributions to these accounts are not tax-deductible, but all withdrawals are tax-free in retirement. However, unlike a Roth IRA, Roth 401(k) accounts must still take the required minimum distributions starting at age 72.
  • Behind in goals. If you are behind in your savings goals, it makes sense to max out your retirement savings accounts as much as possible. This helps to catch up to your goals and puts as much money as possible into tax-deferred retirement accounts.

Consider using an IRA

In addition to a company retirement account, many investors also contribute to an Individual Retirement Account (IRA). These accounts also have a maximum contribution limit, but it is much smaller than the amount you can contribute to a 401(k). The maximum contribution limit is $6,000 in 2022. Plus, workers over 50 years old can add an additional $1,000 as a catch-up contribution.

However, be aware of income limitations that affect how much you can contribute to an IRA if you have access to a company retirement account. Even if you don't contribute to your 401(k), these rules still apply to you.

When a worker has access to a 401(k), their ability to contribute to a traditional or Roth IRA is based on their income, marital status, and tax filing status. The amount that you can contribute phases out based on how high your income is within the range. If your income is above these ranges, you cannot contribute at all.

401(k) and taxes

Some of the biggest advantages of contributing to a 401(k) for retirement are the tax advantages. Depending on your choice of a traditional or Roth 401(k), the tax treatment of contributions and withdrawals is different. However, the money in both accounts grows tax-deferred, which means that you won't receive a tax bill for dividends or capital gains earned inside the account.

Traditional 401(k)

A traditional 401(k) allows contributions to be made pre-tax. This means that your taxable income is reduced dollar-for-dollar by the amount that you contributed. However, when you withdraw money in retirement, the distributions are taxed at ordinary income rates.

Additionally, if you withdraw money from your traditional 401(k) prior to 59 1/2, there is a 10% penalty on the withdrawals. If you retire early, there is a provision called 72(t) that allows for "substantially equal payments" for at least five years without penalty.

Roth 401(k)

Roth 401(k) contributions do not receive a tax deduction in the year they are made. However, when you withdraw money in retirement, all of the distributions are tax-free.

Non-penalty withdrawals

There are exceptions where you can take withdrawals from your 401(k) that do not trigger the 10% penalty. These include unreimbursed medical bills, disability, health insurance premiums, and IRS taxes. Additionally, you can withdraw up to $10,000 to buy a house as a first-time homebuyer. 

How to max out your 401(k)

Maxing out your 401(k) is a solid strategy if you want to have a successful retirement. With the ability to save more than $20,000 per year in a tax-advantaged account, your money will grow faster without paying additional taxes each year.

If you'd like to max out your 401(k), here are a few strategies to help you achieve this financial goal:

  • Equal paycheck contributions. The most common method is to spread your contributions throughout the year. Take the maximum you are allowed to contribute and divide by the number of paychecks you receive each year. For a 40-year-old who gets paid twice a month, they would divide $20,500 by 24 paychecks to equal a contribution of $854.16 per pay period.
  • Front-load contributions. People who have higher incomes or lower expenses may want to max out their 401(k) as early as possible. Depending on their company's 401(k) plan rules, they can contribute up to their whole paycheck each pay period until they've reached their maximum contribution for the year.
  • Align with bonuses or commissions. If you receive bonuses or commissions throughout the year, you can increase your 401(k) contribution rate for the periods that you receive this extra money. This way, you're using "extra money" to make your contributions instead of your normal paycheck.

One of the best ways to save for retirement

Contributing to a 401(k) is one of the best ways to save for retirement. The contributions are made automatically from your paycheck, and you receive tax benefits on your account. The average worker can save over $20,000 per year, and those 50 and older can save extra to "catch up" on their retirement savings. Matching contributions from your employer provide extra growth for your account, but you may have to stay at the company long enough for them to vest. If you can, try to max out your 401(k) contributions to maximize your benefits and reach your retirement goals faster.