This year the 401(k) contribution limit goes up again — that sometimes-argued-about but widely used retirement account gets a boost. In 2017, the pre-tax limit rose from $18,000 to $18,500, and on January 1, 2019 it increases to $19,000. Early in your career, you should ask yourself how much to save.
In our house, we put just 6% of the author’s pre-tax pay into the 401(k). Two reasons:
1) My employer matches dollar-for-dollar up to 3%, then 50 cents on the dollar for the next 3%. That’s free money I’d be leaving on the table if I didn’t at least contribute 6%.
2) I prefer diversification. I stop at 6% and put extra savings into real estate and paying down debt.
I’ve contributed to a 401(k) for most of my working life. Since my first job out of college, making $27,500 a year, the 401(k) has been a fixture. Over time I’ve contributed anywhere from 0% to 15%, and most recently 6% of my gross pay. My wife has never had a 401(k) — her small business profits helped us pay down student loans and our mortgage. We might consider a solo 401(k) for her someday, but with what we’ve built in my employer plan over 22 years, it may not be necessary.
A little history: in the early 1970s, a group of Kodak employees asked Congress to let part of their salary be invested and shielded from income tax. That led to section 401(k) being added to tax rules. The law enabling 401(k)-style plans passed in 1978 to let people defer taxes on income. In 1980, benefits consultant and attorney Ted Benna noticed the provision and used it to create a simple, tax-advantaged retirement plan. He later set up the first 401(k) at his employer, the Johnson Companies. Back then, employees could contribute up to 25% of salary, capped at $30,000 a year.
It’s interesting history. Thanks to those Kodak folks and a few others, traditional pensions declined and 401(k)s became widespread. Despite mixed motives, 401(k)s offer real advantages. First, employee pre-tax contributions reduce taxable income (except for Social Security and Medicare taxes). That’s especially helpful as your earnings rise. Second, investment growth — dividends and capital gains — isn’t taxed while it’s in the account. You will pay ordinary income tax on withdrawals in retirement (see PRO TIP below).
You can begin penalty-free withdrawals at age 59½. By then you’ll likely be in a lower tax bracket, but watch out for Social Security benefits and required minimum distributions (RMDs), which can push your tax bracket higher in your 70s.
With those tax perks and the long-term rise of the market, some readers may want to max out the $19,000 limit and save aggressively. But first, let’s make a big assumption: aim for $2 million by age 60. Why $2M? You’ll likely need a substantial amount for healthcare later in life. Fidelity estimates the average couple might need $280,000 for healthcare — roughly $10,000 a year up to age 90. Beyond that, advanced medical treatments and therapies may be expensive and not fully covered by insurance. Wealthier people will have more access to those options.
For now, $2M is a realistic middle-class goal that a hardworking couple can reach if both save consistently and wisely in their 401(k)s. With that nest egg, you could spend about $100,000 a year from age 60, use money for travel, medical costs, charity, and family support.
A story from our household: when the kids were young I stopped contributing to my 401(k) for nearly two years, and I was also laid off for a year in 2002. Those three years of not contributing likely cost us about $100,000 in long-term growth. I don’t regret it entirely — for two of those years we invested extra dollars into high-yield real estate instead.
The key lesson is the power of starting early and contributing even small amounts. In our example, the couple doesn’t put more than 6% into their 401(k) until age 40. If they had saved 10% in their early twenties, they might have an extra half-million dollars by 60. Employer matching is a big reason this works — free money you shouldn’t ignore. Some employers match more than 100% for the first 3%; others less. Consider matching dollars a part of your total compensation. I’d choose a $55,000 job with a 100% match up to 6% over a $60,000 job with no 401(k) match.
A common recommendation is to save 5% to 20% of gross pay in a 401(k), increasing contributions as your income grows. That assumes two earners with solid raises over time. But many families face different realities: one partner working part-time, job loss in a collapsing local industry, or difficulty relocating. If your combined income never exceeds $60,000, you’ll have a harder time covering basics and affording decent housing. There won’t be many luxury vacations. Take examples with a grain of salt; they can’t capture every personal situation.
Still, even in lean years when you don’t contribute, compounding can double your savings if the market performs well and dividends are reinvested. Ideally, try to save 15% of gross pay from early on, if possible. If your employer doesn’t offer a 401(k), open an IRA at Vanguard and consider a taxable investment account too.
When I was single and making $27,500, I only saved 8% — $2,200 a year — because I had student loans and wanted a new car. If I’d saved 15% instead, that extra $2,000 pre-tax would have cost me about $1,500 after taxes — roughly $125 a month. A smarter young-me would’ve bought a reliable used car and put more into retirement. But hey, that old Saturn had pop-up headlights before it rusted.
Looking ahead, if you keep your nest egg in a mix of stocks and bonds (for example, a Vanguard Admiral fund like VTSAX, which currently has a $3,000 minimum), you might expect average returns around 5–9% a year. With $2M at retirement, you could afford about $100,000 per year early on and increase to $150,000 starting around age 80, still leaving roughly $360,000 at age 95. With $1M saved, you might live on $50,000 per year, ramping to $80,000 at 80, leaving about $340,000 by 95. These figures account for rising medical costs and care needs, but they’re in today’s dollars. Inflation — typically 2–3% per year — will reduce purchasing power over time. Social Security might help, but nothing replaces saving as much as you can, as early as you can. Don’t expect to save 50% of your income when you’re starting out, but treat maxing out as a long-term stretch goal.
A quick reality check: the market isn’t predictable, although it’s historically trended up over decades. You could save for decades and see your balance cut in half during a crash like 2008. The good news is markets usually recover, but if you’re close to retirement a big drop can be frightening. I’ve seen people delay retirement after big market losses because they’re spooked.
Another downside of 401(k)s is administrative fees. These are the costs to run the plan and can eat into your returns. Large companies (10,000+ employees) usually secure lower fees, often around 0.25%. Small employers (100 or fewer) might face fees of 0.75–1.0% or more because they have less bargaining power. Do the math — a 1% fee over a career can cost you well over half a million dollars. If you can’t change employers, study the funds offered in your plan. Many plans include index funds that track the total stock market or the S&P 500; these tend to have lower fees because they require less active management. I put my 6% into a Vanguard large-cap fund with fees below 0.25%.
A few final tips: time and consistent contributions are what matter most. Even if you can’t max out your 401(k), steady saving builds a sizable retirement nest egg. This year alone, 168,000 Americans saw their 401(k) balances top $1 million — a 41% increase. That club is growing and it’s not as exclusive as you might think.