How to pick a 401(k) contribution rate

Your 401(k) contribution rate - also known as a deferral rate or savings rate - is a key part of a successful retirement strategy.

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You’ve taken that first step and have set up your Betterment 401(k) account - well done!

One important piece to consider next is your contribution rate - how much from each paycheck will go into your account? With your Betterment 401(k), you could use a percentage or a fixed dollar amount, whichever you prefer. Here are a few things to consider:

Were you automatically enrolled?

Many employers choose to automatically enroll their employees in the plan with a default contribution rate of 3% – if you're not sure, please check with your employer. Keep in mind, whatever the default contribution rate is, it’s just a starting point. You can (and probably should) increase that contribution rate at any time in your account.

At least a decade without a paycheck

Most experts recommend contributing 10%–15% of your paycheck to have enough to last you through retirement - which could be 20-30 years considering how long people are living! If you retire at age 65, with a healthy lifestyle and no major risk factors, you could live well into your 80s or 90s. You want to set yourself up for living off your personal savings and investments for about 20 years!

Starting small is better than nothing

If 10-15% of your paycheck sounds absurd to you right now - deep breath, think of that as something to aim for. You can start with something smaller, maybe 5 or 6%, and slowly but surely increase your savings rate every year – your birthday? Give yourself a gift and increase it by 1%. Your work anniversary? Cheers to you, bump it up again. And those 1% increases can actually be a big deal as this next chart illustrates.

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Balances were estimated assuming a starting salary of $50,000 with 3% annual increases, a starting contribution rate of 6%, and an annual investment return of 6%. Balances were calculated net of a 0.25% management fee. “Increase 1%/yr to 10%” assumes contributions are increased 1% per year until a max contribution rate of 10%.“Increase 1%/yr to 15%” assumes contributions are increased 1% per year until a max contribution rate of 15%. “No increase” assumes no increases are made to the 6% contribution rate. 

Not illustrative of actual client performance, which may vary. Investing involves risk. The investment performance is not attributable to any actual Betterment portfolio nor does it reflect any specific Betterment performance. Hypothetical examples are for illustrative purposes only, and market conditions can and will impact performance.

Go for the max

Because of its tax benefits, the IRS sets a limit on how much you can put into your 401(k) every year. So you could aim to contribute as much as the IRS allows! For people 50 and over, the limit is higher, which is referred to as “catch-up contributions.” And if you really want to be an over-achiever, you can also contribute to an IRA, an individual retirement account, to save even more.

Tax considerations

With your Betterment 401(k), you can make contributions into a traditional 401(k) account and/or a Roth 401(k). There are tax benefits to both:

  • Traditional 401(k): Contributions are deducted from your paycheck before taxes are withheld, which can lower your taxable income. Both your contributions and investment earnings are “tax-deferred,” meaning you won’t pay taxes on what you contributed to the account as well as any earnings until you withdraw the money at retirement. In other words, save on taxes now, pay taxes later.
  • Roth 401(k): Contributions are made with after-tax dollars so your withdrawals—both the contributions and earnings—are tax-free once you decide to retire (minimum age, 59½), and as long as you’ve held the Roth account for at least five years. In other words, pay taxes now, no taxes later.

A common strategy is to split your total contributions between the two! Say you want to contribute 10% towards your retirement? You can put 5% into a traditional 401(k) and 5% into the Roth 401(k). This is one way you can balance your tax exposure.

If you already have your account set up, log in today to increase your contribution rate or reassess your traditional and Roth contributions.

Haven’t started saving in your Betterment 401(k) yet? Check your email for an access link from Betterment, or get in touch:

Send us an email: support@betterment.com

Give us a call: (718) 400-6898, Monday through Friday, 9:00am-6:00pm ET