As a VERY general rule-of-thumb, the amount you contribute to your company retirement plan will have a greater impact to your overall account balance than the portfolio’s investment performance until the overall account reaches approximately two times your annual income.
To say it a different way, if you are unhappy with the pace your retirement account is growing, look first at how much you’re contributing and then review its investment allocation. That contribution amount can have a great effect on your nest egg as you save over time.
For example, Dave is a 40-year-old HR coordinator making $50,000. His company offers a 3%, dollar-for-dollar match on his 401(k), and he began participating 10 years ago when he felt like it would be a good idea to start saving for retirement. He’s contributing 3% out of his paycheck to make sure he gets the match, but that’s all.
When Dave turned 40, he wanted to get more serious about saving for retirement, so he was ready to increase his contribution. But what would be the impact? He had accrued $40,000 to this point, but he wanted to see his balance grow faster. He used a retirement plan calculator and determined he really needed to be saving 14.5% (including his company match) to reach his goal, but he couldn’t make that big of a leap just yet, so he decided to increase his contribution to 7% (totaling 10% with the company match).
Over Dave’s remaining 25 years before retirement, this change from 3% to 7% could increase his overall retirement account balance by more than $205,000 assuming a moderate investment return*. His “out-of-pocket” amount would be just shy of $73,000.
Bottom line, employee behavior related to retirement plan savings effects the most change on your nest egg. Remember that when you contribute to your 401(k)**, it is a before-tax contribution which means it won’t hit your take-home pay as hard as you may think. A $100 contribution may only feel like $80 depending on your tax withholding.
*Assumes 8% rate of return (all investments contain the risk of loss of principal). Salaries in this example are adjusted for inflation at a rate of 3% per year.
**Roth 401(k) contributions are after-tax – contributions have a dollar-for-dollar impact on your take-home pay