If you have access to a 401(k) plan through your job, then you have a prime opportunity to build yourself a nice nest egg. Not only do these plans come with generous contribution limits ($22,500 this year for workers under 50, and $30,000 for those 50 and older), but many employers who sponsor 401(k)s also match worker contributions to some degree.
So all told, you could wind up with a very large amount of savings by consistently funding a 401(k). And that’s important given that Social Security cuts are a distinct possibility.
Meanwhile, recent research from Vanguard found that 401(k) plan contribution rates have risen over time. That’s the good news. The not-so-great news, however, is that even with that increase, workers today may not be funding their 401(k)s at the level they should be. And that means they risk facing a financial shortfall once they retire.
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Contribution rates are up, but they may not be enough
In 2006, Vanguard found that the average percentage of salary contributed to a 401(k) plan was 7.2%. Among all plans, that rate increased to 7.7% by 2021.
Now clearly, it’s good to see that workers are putting more money into their 401(k) plans these days than they did in the past. But it’s also important to note that generally speaking, workers are advised to part with 15% to 20% of their income for retirement savings purposes. And there’s a reason for that.
First of all, as mentioned earlier, Social Security may be forced to cut benefits in a little over a decade if lawmakers don’t find a way to address the program’s financial shortcomings. That could leave future retirees in a really bad spot if they don’t compensate with extra savings.
But even if Social Security cuts don’t come to be, the reality is that those benefits will only replace about 40% of the average worker’s pre-retirement income. Most seniors need about twice that much income to live comfortably, and a robust nest egg may be needed to make that happen.
That’s why workers are generally encouraged to bank 15% to 20% of their income for retirement savings. To put it another way, if you limit your 401(k) plan contributions to just 7.7% of your income throughout your entire career, you may be forced to make lifestyle changes once your time in the labor force comes to an end. That could mean having to downsize your living space, cut back on leisure spending, and generally pinch pennies to avoid late-in-life debt.
Aim to ramp up
If you’re currently saving 7.7% of your income in your 401(k) plan, give yourself a pat on the back for prioritizing your retirement. But also, aim to increase your contribution rate over time.
This doesn’t mean you must go from saving 7.7% of your income to saving 15% overnight. But maybe next year you’ll bank 9.5% of your salary, and then 11% of your salary the year after that so that eventually, you’re funding your nest egg at a rate that’s far more likely to lend to future financial stability.
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