By: Mike Earl, CFP®, CPWA®
It's a phrase we have heard many times during meetings: "I max out my 401(k) every year." We typically reply back with something like this: "Wow, you contribute $18,000 of your pay to your 401(k) each year?" (or for people over age 50, $24,000 per year). Typically, the answer we hear back is no, they are not actually maxing out their 401(k).
For many people, "maxing" their 401(k) indicates they have contributed enough dollars to earn the full employer matching contribution. If an employer provides a full match when the employee contributes 6% of his pay, then many employees consider a 6% contribution rate to be "maxing" their 401(k). Au contraire, friend.
One of the biggest hurdles we face as financial coaches is helping our clients benchmark to an appropriate standard. Since we know that most Americans are not on track financially (50% of Baby Boomers have less than $100,000 saved for retirement), we don't want our clients to benchmark themselves to what other ordinary Americans are doing. Many middle-class Americans look rich on the outside (fancy cars, big homes), but they are actually loaded with debt and don't have much of an investment portfolio.
When an employee hears that a 6% contribution rate to their 401(k) will earn the maximum company match, it's really easy to slip into thinking that a 6% contribution rate means you're doing a good job of saving for retirement. The reality is just the opposite. Here is how we at The Wealth Group consider retirement savings percentages:
Vanguard now oversees 3,900,000 401(k) accounts nationwide, so the data they provide on those plans is a great barometer for national retirement savings. Vanguard indicates that just 12% of plan participants are contributing the maximum amount they're allowed to contribute every year. The median contribution rate is just 5.9%.
Our experience and research has shown that households saving 15% or more of their gross income toward retirement are on the certain path for financial success. For those reaching higher heights of 20%, 25%, or even higher retirement savings percentages, Financial Independence will simply arrive much sooner than the conventional retirement sometime in one's 60s. That means work becomes optional anywhere from 10 - 25 years sooner than your peers.
What should you do? If you're under that 15% retirement savings rate, consider increasing your retirement savings contributions by 1% or 2% right now. Then, revisit it again in 3 months. If you slowly increase the contribution percentage every so often, you may not notice much of an impact to your lifestyle. In a relatively short period of time, you can get to that 15% mark.