How can I figure out if I'm saving enough in my 401k?

Add your answer

Have a question?

Get answers from our expert nerds.


chat

mail

Expert Answers

  • 15 people found this answer helpful

    CPWA Berkeley, CA

    There are 5 pieces of information that are absolutely required to answer the question, "Am I saving enough?"  You need to know 1. How much you have saved; 2. When will you start withdrawing; 3. How much you will spend in your 1st year of retirement; 4. How much you will receive from Social Security and Pensions; and 5. For how long will you require a retirement income.  And, this 5th item being a total unknown, you will need to plan for a VERY long time.

    Then, of course, you will also need to project a couple more things that are completely and totally unknowable, but for which history gives us a decent guide (though never a guarantee).  You will need to estimate an average rate of inflation (the amount by which your cost of living will increase every single year while buying the exact same items).  And you will need to estimate an average long-term return.  More on these in just a moment.

    Once you have all these numbers, it is easy to determine if you are saving enough.  Here are the steps:

    1.  Figure out your retirement income GAP.  This is the amount you will need, over and above your social security and any pension income you may have, to meet both your fixed and your variable lifestyle expenses.  Simply consider your current expenses as your NEED, subtract your expected social security and Pension income and viola – you know your GAP.

    2.  From this GAP, you can estimate the size of the pool of assets you need in retirement to create this income.  The available “rules of thumb” for a lifetime sustainable withdrawal rate vary between 4% and 5%.  In other words, take your GAP number and divide it; first by .04 then by .05, to determine the required size of your asset pool before you retire.  If you need $25,000 over and above your social security and pension incomes, this means you will need $500,000 - $625,000 before you can retire with confidence.

    3.  Determine how many years you have to save before your date of retirement.

    4.  Using a financial calculator, solve for required savings.  The financial calculator will require that you input a PLUG number for “performance.  For planning purposes, I recommend 5% if you are conservative and 8% if you feel you can handle an above average amount of volatility (risk).  NOTE:  using the lower number will force a higher savings rate to fill the gap, while using the larger “return” number will allow a lower savings rate (and therefore more current spending).  If you go for the high number, you will have to work harder to bolster you belief in the plan as you will be tested more often and with a greater severity by the volatility of the market.

    This material is for informational purposes only.  Individual circumstances will vary.  The hypothetical rates used do NOT reflect the deduction of fees and charges inherent to investing.

    Why do we need such a high return?  Why can’t I just invest in CDs and trust that will get me there?  Simple, with long-term inflation averaging 3.5%, that is the minimum we absolutely require of our portfolios OVER AND ABOVE OUR ACTUAL WITHDRAWALS – just so we can keep pace with our rising cost of future living expenses.

    Historically, 3.5% will work over the long term, but we actually recommend using 4% as a plug number.  Better to be conservative in your plan and force yourself to save more than to “bet” on low inflation and run out of money. 

    And, you will need to estimate an average long-term return.  This, admittedly, is a total crapshoot in the short-term.  No one has any idea what economic calamity is hiding just around the next corner… but I am fairly certain there is one.  This being said, it is nothing new and THAT is the primary point.  All the short-term shenanigans that people play to anticipate market falls or to “load up” before a big pop are just speculation.  We have 3 basic tools that when practiced with patience, discipline and a belief in our collective long-term future will create success.

    They are Diversification, Asset Allocation, and Rebalancing…

    The only thing we know is that a broadly allocated portfolio participates less than the best performing markets while also participating better than the worst performing markets.  It is a voluntary agreement with heaven to NEVER MAKING A KILLING for the priceless blessing of NEVER GETTING KILLED.  And, it absolutely works over time, though there cannot be any guarantee.

    Any process or plan that entails trying to figure out what will be the NEXT best thing, is a speculation and speculators don’t succeed… at least not for very long.  We do not recommend speculation; rather we suggest that we focus on time tested long-term thinking.  Stay broadly allocated, stay diversified, consider valuation, and rebalance at least annually.

    If you follow the above 4 steps to figure out how much you need to save, follow through and actually save that amount AND you stay resilient through the tough times (which will inevitably come when we don’t expect them, last longer than we would like and be accompanied by catastrophic media headlines suggesting the END OF THE WORLD)… you will get there. 

    Though, and this is the rub, there are not and can never be any sort of guarantee.

     

    The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.  To determine which investments may be appropriate for you, consult your financial advisor prior to investing.

    There is NO guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.  Diversification does not protect against market risk.

    Rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment.

     

     

    Was this answer helpful?

    Advisors offer free consultations to determine if you're a good fit for one another. Providing more information in the consultation request will help advisors have a better sense of what you're looking for. The advisor will contact you via email and set up a time to meet. Depending on the advisor, and your preferences, this could be an in-person or online meeting. You are under no obligation to engage them after meeting with them.
    • Embed ›
    • 1548 views
  • 9 people found this answer helpful

    CFP® Monterey, CA

    I’d like to tweak this question a little to, “How can I figure out if I’m saving enough for retirement?”

    One general rule of thumb is 15 to 20% of your income should go towards retirement. Of course, this isn’t the case for everyone. Maybe you have irregular income or you’re playing catch up because you’re getting closer to retirement.

    The quick answer to the 401(k) question is to max it out every year. Not all of us can afford to do that and have enough money left over to live. If that is the case, be sure to automatically put some money away for retirement each paycheck. When small amounts are consistent they tend to add up over time. If your company matches part of your 401(k) contribution then be sure to do whatever it takes to maximize the match. Otherwise it’s like leaving compensation on the table.

    There are other ways to come up with a figure that is more personalized to you. Calculating the amount of savings you need to retire is not an exact science. In other words there is no perfect calculation. I’ve been known to say, “I have software, not a crystal ball.”

    There are numerous online calculators (such as, Bank Rate, Choose to Save and CNN Money) that can help you arrive at a retirement savings figure. The assumptions you use in these calculations can have a profound effect on the outcomes. The saying is “garbage in then garbage out.” Give yourself a realistic range for each figure and “play” with the numbers. Remember that this calculation needs to be re-examined periodically and when circumstances change.

    Let’s jump back to the original question and look at factors to consider as it specifically pertains to the 401(k). Be sure you have enough money outside your retirement account for emergencies (3-6 months of expenses is a general rule of thumb) before you start contributing. There are steep penalties for pulling from retirement funds prematurely. There are very few circumstances when it is appropriate to pull from these accounts early.

    Consider the investments your 401(k) plan offers. What are the fees? How much diversification is available to you? You also want to take your tax situation into account. Perhaps you are in a high-income bracket and the 401(k) deduction is helpful. Or, if you aren’t making much at the moment a Roth IRA might be an effective account for the contribution of some of your funds.

    I help clients with a number of retirement related issues such as examining likely cash flow scenarios (i.e. we answer the question “Will I run out of money?”), help them establish an appropriate retirement savings amount and review investment options. The use of professional software is a helpful tool because it allows me to customize assumptions for clients and look at a variety of “what if” scenarios.

    Once you know how much you need to save then you have to figure out how to make it happen. That is a matter of examining other aspects of your finances and creating strategies that work for you.


    Was this answer helpful?

    Advisors offer free consultations to determine if you're a good fit for one another. Providing more information in the consultation request will help advisors have a better sense of what you're looking for. The advisor will contact you via email and set up a time to meet. Depending on the advisor, and your preferences, this could be an in-person or online meeting. You are under no obligation to engage them after meeting with them.
    • Embed ›
    • 1198 views
  • 1 person found this answer helpful

    CFP® San Ramon, CA

    Like most financial questions there is not an easy applicable rule of thumb to apply. In general it’s save as much as you can, but in reality there are usually more things to consider.  Among them are:


    How would more savings affect your budget?  I always recommend saving as much as you can within reason.  What I mean by that is save a significant amount that fits your income well but do not sacrifice your complete happiness for your current savings. Do not eat a bowl of plain white rice every night so you can put an extra $50.00 away each paycheck from the food savings.  One of the great things about traditional 401(k)s is that since it is tax deferred you can save a higher amount then you feel out of your take home pay.  For example, an additional $100.00 per paycheck will usually only cost you around $65-$85 dollars out of your take home pay because of the money that would have gone to taxes.


    Is there any match available?  One of the biggest no-brainers in the investment world is get the free money. If there is a match available from your employer and you are not saving enough to get all of it then you need to work to increase your savings to take full advantage.


    Are there competing goals for the money?  We usually have multiple goals for our money and balancing them appropriately is the tricky part. For example, a new couple might prioritize saving for a home over the 401(k) (although probably not completely).

     

    What are your retirement goals?  How much do you need to save to fund the lifestyle you wish to have in retirement?  Most people do not realize the amount of principle needed to fund a retirement at roughly the same level of income as when they were working.  That figure can be a shocker and motivate you to up your contributions.


    What are reasonable estimates of your future ability to save?  You may be new in your career but have reasonable expectations of making more in years to come and having more opportunities to save.


    One of the easiest ways to increase your contributions is do it gradually over time.  Every time you get a raise put half (or more) of the raise toward your 401(k).  After doing this for a few years you may be shocked at how much you are saving and how big your account is getting.  What a great feeling to have!




    Was this answer helpful?

    Advisors offer free consultations to determine if you're a good fit for one another. Providing more information in the consultation request will help advisors have a better sense of what you're looking for. The advisor will contact you via email and set up a time to meet. Depending on the advisor, and your preferences, this could be an in-person or online meeting. You are under no obligation to engage them after meeting with them.
    • Embed ›
    • 2242 views
  • 0 people found this answer helpful

    CFP® Leesburg, VA

    No way to know without looking at your total situation but I think you may be asking how much you should save in a 401k? To read some fairly scary research on 'saving enough' check out this blog - http://wpfau.blogspot.com/ and his thoughts on how much to save.  It is so much more than people realize.  And without tying it even to retirement, let's think about having the freedom of choices if you really save hard and early (starting a business, investing, etc.)

    So are you saving enough?  Probably not (we have very good research that shows few Americans are, http://www.ebri.org/).  Remember, investing can rarely overcome a lack of savings - keep saving!


    Was this answer helpful?

    Advisors offer free consultations to determine if you're a good fit for one another. Providing more information in the consultation request will help advisors have a better sense of what you're looking for. The advisor will contact you via email and set up a time to meet. Depending on the advisor, and your preferences, this could be an in-person or online meeting. You are under no obligation to engage them after meeting with them.
    • Embed ›
    • 985 views
  • 0 people found this answer helpful

    CFA Los Altos, CA

    As noted in prior posts, there are a lot of things that go into determining "how much to save", but it invariably boils down to something similar to the following:

    Shoot for 20% of your pre-tax income - if you can do that without withdrawing early, you should be fine going into retirement.  That 20% can be a combination of funds you set aside through a 401(k) plan, or private savings.

    If you can't do this amount, then get as close to it as possible.

    Was this answer helpful?

    Advisors offer free consultations to determine if you're a good fit for one another. Providing more information in the consultation request will help advisors have a better sense of what you're looking for. The advisor will contact you via email and set up a time to meet. Depending on the advisor, and your preferences, this could be an in-person or online meeting. You are under no obligation to engage them after meeting with them.
    • Embed ›
    • 12 views

Add Video

Upload

Add Video

100%

Please wait while your file is being uploaded.

Add Video

How to Save for a Mortgage

Video Uploaded

Add Another I'm Done

Preview Video

*Disclaimer: We try to keep information accurate and up to date, however we cannot make warranties regarding the accuracy of our information. Please verify FDIC Insurance / NCUA Insurance status, credit card information, and interest rates during the application process. Please note that NerdWallet has financial relationships with some of the merchants mentioned here. NerdWallet may be compensated if consumers choose to utilize the links located throughout the content on this site and generate sales for the said merchant.

© Copyright 2014 NerdWallet, Inc. All Rights Reserved. Privacy Policy|Terms of Use
Nerdwallet, Inc. is a BBB Accredited Financial Service in San Francisco, CA