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

Thursday, Jul 01, 2021

Many employers offer a 401k plan for retirement savings. Have you ever asked yourself any of the following questions?   

  • How much should I contribute?
  • How much does the match matter?
  • How much do I need to put in each pay period to ensure the retirement of my dreams?!?

A 401(k) can be a great option for retirement savings, but it is not the only option. There are several ways to build a long-term financial plan for success and achieve those important retirement goals. Read on for an exploration of saving options and how they work together for your best benefit. 

How much can I contribute? 

A 401(k) is an employer sponsored retirement plan where an employee can make contributions up to certain limitations, and the employer can also make contributions up to certain limitations. Under current law, the employee can put $19,500 per year into a 401(k) plan. Some 401(k) plans allow only pretax contributions where others also allow Roth contributions. Regardless of whether you contribute to the pre-tax or Roth portions of your plan, the employee can only contribute $19,500 per year. If the employee is 50 years old or older, they can contribute an additional $6,500 as a “catch-up” contribution. The employer can elect to match your contributions, or they can share profits occasionally directly into the plan. 

How much should I contribute? 

Great question! And the answer lies in knowing your specific retirement goals. As a baseline, it often makes sense to maximize the employer match by putting enough into the 401(k) so that you will get the full amount that the employer is offering as a match into the plan. For example, your employer says they will match up to 3%. It’s a great practice to contribute at least 3% so you can get that full match, commonly referred to as “free money”. Who doesn’t want some free money? 

Once you have maximized your employer match, you may want to contribute more to the 401(k) plan, but first, consider the following in light of your own circumstances.   

If you have a high income, you may want to put more into the pretax portion of your 401(k), because you get a dollar-for-dollar deduction on your tax return for contributions to pretax 401(k) plans. There is no income limitation on this deduction, making it an important one for high income folks to consider in reducing their overall annual tax liability.  

You may be surprised to find out that you are unable to contribute to a Roth IRA.  Roth IRAs have contribution limitations based on income. A single taxpayer cannot contribute to a Roth if their adjusted gross income was above $139,000 in 2020 ($140,000 in 2021). A married couple filing jointly cannot contribute to a Roth if their income was above $206,000 in 2020 ($208,000 in 2021). If you fit into this category, you may want to see if your 401(k) allows for Roth contributions. This is a way that you can still contribute to a Roth retirement plan if you are over the income limits to contribute to a Roth IRA. The income limitations do not apply to 401(k) plans, even the Roth portion of the 401(k). This could be another reason you contribute more to your 401(k) plan than what is needed to maximize the company match. 

Where else can I save?  

Although commonly thought so, 401(k) plans are not the only way to save for retirement! There are several types of accounts for you to utilize. These accounts can have beneficial liquidity options as well as better tax rates. Diversity can be a key component of your overall portfolio – more on that in a minute!  

The most popular alternative options to a 401(k) plan are nonqualified brokerage accounts, a Roth or traditional IRA, life insurance, and real estate investments. Let’s examine the advantages and disadvantages of each option.   

Nonqualified Brokerage Account  

A nonqualified brokerage account is a fancy name for a regular old investment account that is not a retirement account of some sort. Think of this account just like your savings account at your bank although you can purchase securities inside of it like mutual funds, stocks, bonds, or exchange traded funds. These accounts are unique from a tax perspective because they are subject to capital gains tax as opposed to income tax. Generally speaking, gains in a nonqualified brokerage account are taxed at long-term capital gains rates if you’ve held the security for more than one year before realizing the gain. Currently, for most people, capital gains rates are 15% when long-term. This rate is often lower than one’s income tax rate providing an advantage from a tax perspective. In addition, nonqualified brokerage accounts are liquid, meaning that you can put money into them and remove money without any age restrictions. This differs from most retirement plans which have penalties for accessing funds prior to age 59 1/2. So having a nonqualified brokerage account as part of your long-term plan makes sense from a tax and liquidity perspective. 


Both Roth and traditional IRAs can be useful as well. Depending on your income and whether you have a retirement plan through work that you are participating in, you might find some tax benefit in using a Roth or traditional IRA. Check with your tax pro to make sure you are under the deduction limits specific to your filing status. If you are, your traditional IRA contributions are deductible on your tax return. Hooray for instant tax savings!  

You can also contribute to a Roth IRA, if you are beneath the income limitations discussed earlier. While there is no deduction for a contribution to a Roth IRA, the gains in a Roth IRA become 100% tax free after age 59 1/2 if the IRA has been in existence for more than five years. 

Life Insurance 

You can use cash value life insurance as a portion of your long-term plan. Cash value life insurance involves an insurance component and a cash value account component. Cash value life insurance can be complex, and a thorough analysis of whether implementing it makes sense should be done for each individual situation. However, broadly, life insurance can provide for a tax-free bucket of money prior to age 59 1/2 if done correctly. Life insurance distributions are principle first, making it very unique in the investment world. Most investments require gains to come out in some form or fashion when you take a withdrawal. This is not the case in life insurance. Your contribution amount can come back to you first and tax free. This can make using cash value life insurance an attractive option for college planning or any other large expense that you plan to have in ages 40 to 60. This type of planning generally works best when you establish the cash value insurance at a younger age, around 30 to age 40, and build the life insurance cash value over 15 to 20 years. It takes time to realize the strategy, but it can be a good one for young families planning for funding college expenses after they have had a couple of kids.  

Cash value life insurance can also be a useful tool for high net worth individuals who may be subject to estate tax at the end of their lives. While this is difficult to plan for because estate tax law changes frequently, life insurance death benefits are generally tax free. This means that an irrevocable life insurance trust could be established and the life insurance of a high net worth individuals placed inside the trust. As placing the life insurance inside of your irrevocable trust removes that life insurance policy from the estate, these proceeds will not generate additional estate tax but can be used instead to cover the estate tax of other parts of a high net worth individual’s portfolio. 

Real Estate 

Real estate can be a useful place to put savings if one is comfortable with the concept. You can access real estate investments through exchange traded securities or you can buy actual real estate on your own. Either way, exposure to the real estate market in the United States is generally a good idea for long-term investors. Perhaps the most popular way of doing this is through purchasing a rental property. A rental property can be an amazing wealth creator because you can purchase a property using a loan, and you pay off the loan with the rental income. Essentially you can purchase a property with a 20% down payment and have that loan paid off for you by somebody else. The kicker is that you get to keep all of the equity proceeds as the loan is getting paid off. So, not only do you get the appreciation of the real estate over time, but you also get the equity increase as the principle of the mortgage is paid off by someone else. Here is an example of how this might work. 

Let’s say you purchase a rental property for $400,000 in July of 2021. You put 20% down, and get a 3% interest rate on your 30-year loan. With property taxes, insurance, and HOA, your total payment is about $1,850 a month. For the location of this property and the amenities offered, you determine you can charge $2,500 per month for rent. This allows you to cover your monthly payment with $650 left over! Now let’s say that by 2035, the value of this property has doubled. In 14 years, you would have around $626,600 in equity without ever covering your mortgage on your own, assuming you never took the equity out or refinanced your loan.  

How do I decide how much to put in all these areas? 

This is a complex question and one that is dependent on your financial circumstances and retirement goals. Every financial plan is different – and that is why financial planning exists! If it were easy, everyone would do it.  

Do you want to retire at age 50? If so, you may want to have a large amount of your savings going towards nonqualified brokerage accounts for liquidity purposes.  

Do you want to have a retirement based on stable income? If so, you might want to consider investing in real estate and focus on paying down the mortgages of the rental properties you purchase. This way, once the mortgages are paid off, the rental income that comes to you is generally usable as a passive living income.  

Are you worried the taxes will be higher in the future? If so, you probably want to overweight your contributions to Roth IRA’s or Roth 401(k)s. Even though this forces you to not take tax deductions in the year that you make those contributions to a Roth, you will have a large amount of tax-free money in the future, and if taxes are higher, you will not be impacted. 

Are these questions giving you a headache? Don’t worry. We are here for you. 5280 Associates engages with you to answer all these questions and so many more – all for one flat fee. Perhaps you want to continue managing your money on your own, but need guidance in doing so? We specialize in providing our clients high-quality, custom, long-term financial plans, regardless of whether we are managing the money.  

So… how much do you need to save for retirement and where should those savings be?  

We can’t tell you until we know you. Come on in! Let’s talk.  

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