You've likely been told the more you contribute to your 401(k) the better. But, do situations exist where you are contributing too much? Here are three questions to consider when deciding how much money you should put into your 401(k).
Are you contributing too much to your 401(k)?
Should I be contributing at all?
If you follow the Dave Ramsey "Baby Steps", you won't even be saving for retirement until Baby Step 4 - after you pay off all of your debt (except mortgage) and have a fully-funded emergency fund. So, in theory, if you have debt and no emergency fund in place, any money you put into a 401(k) is "too much". Many people will argue this is a bad plan because you might be leaving money on the table especially if your employer matches a percentage of your contribution. We can appreciate both modes of thinking. Bottom line, if you're currently contributing to your 401(k) and you have debt and little to no emergency fund, you may want to consider backing off on those contributions *temporarily* to attack debt and an emergency savings.
What’s the ideal percentage I should contribute?
Dave Ramsey recommends you contribute 15% of your household income into retirement. Again, we tend to agree with Dave on this point. However, if you're approaching retirement sooner than later, you may consider increasing that percentage. The biggest danger to putting in less tan 15% of your income is that you won't have enough to retire. Just a reminder, the progression of saving for retirement is to start with your company match, then contribute to a Roth IRA. If at that point, you're still not up to the 15% threshold, go back and increase your un-matched contributions in your 401(k).
What are the dangers of contributing more than 15% of my income?
We certainly don't want to discourage you from putting large proportions of your income into your 401(k). Assuming you are on Baby Step 4 or beyond, you may want to consider a different retirement vehicle - something non-tax-deffered like a Roth IRA. The reason for this is to alleviate your tax burden once you retire or draw on those funds in the future. Again, consider what Dave Ramsey says; if you have extra money each month after you save 15% of your income into retirement, then focus of saving for kids' college and/or paying extra on your mortgage.
If you have questions or concerns regarding your 401(k), please, give me a call at 320.222.4236 or email [email protected].