If you’ve made it this far, you’re kicking some serious financial butt! Pause a moment to think about it. You created–and hopefully stuck to–a lean budget, began contributing enough to your 401(k) to get your employer’s full match, paid off all non-mortgage debt, AND maxed out your Roth IRA! That’s a lot.
If you’ve got a $45,000/year salary, that means you’re saving almost 20% of your income for retirement, plus whatever your employer is matching. That’s an incredible number compared to the average American who is only saving 5.6%. It is safe to say that you are well-above average in terms of finances now. Quite honestly, average, when talking about personal finance is really quite terrible. Average is what causes stress with a layoff, forces you to work at Walmart during retirement, and lose even more hair when the next government shut-down threatens your social security check.
You’re about to get even more excited after you read this example. Let’s say that you’re 24 years old and make $45,000/year. Would you believe that if you’ve followed Phases 1 through 5, you’ll be a millionaire by the time you’re 54 years old? That figure does not even factor in any promotions, successful ventures, or other sources of increased income. Make no mistake about it; you are making yourself rich. You’ve been taking some serious wealth-building steps. Get pumped.
About Phases 6 & 7
Feel free to prioritize Phases 6 and 7 a little differently depending on your income level and goals. For example, if you’re making $70,000/year, consider getting your 401(k) up a little higher until you’re saving 20% or more for retirement. On the other hand, if you’re making $45,000/year and are wanting to save up for a house, it’s ok to leave your 401(k) at your employer’s match level, max your Roth, then start saving up for that down payment. Once you purchase the house though, that money needs to go right back to the ol’ 401(k).
It is nearly impossible to have one formula that fits every scenario. If you don’t know where to go after Phase 5 (Max your Roth), then follow Phases 6 and 7 in sequence and enjoy the ride. You’ll only be doing things that are beneficial to your net worth. On the other hand, if you feel as though you may need to prioritize a little differently, then go for it. At the end of the day, we’re saving money. Whether its for retirement, for a house, or just to have a nice little stash, we are saving. Saving is the not-so-secret secret to building wealth.
Finally, if you feel stuck, leave a comment on this post about your situation. Reader comments can be great topics for other blog posts.
Back to your 401(k)
This phase is all about increasing the amount you save for retirement by going back to your 401(k) and adjusting your contribution. In Phase 3, you brought your 401(k) contribution only up to the amount your employer matches. In many cases this is around 6%. For some it may be less and for others that are more fortunate, it may be more. Phase 6 is one of the easiest phases because it only involves logging in, changing a number, and clicking submit. You already set up the account and investments in Phase 3.
So why are we stopping contributions at 10%? If you’re contributing 10% to your 401(k), maxing your Roth, and getting a little 401(k) match from your employer, you’re probably saving over 20% of your income for retirement. That’s a fantastic number and there’s no huge reason for saving above that amount if you’re in your twenties. You’re welcome to, but don’t forget that money has uses other than being saved for retirement. It’s ok to save for other things that are in the more near term, like a house or a used car. If you’re closer to retirement and need to play catch up, then you may need to increase your retirement savings rate to a higher percentage of your income.
Bumping your 401(k) up a few more points is not going to make as big of a dent in your take-home pay as you think. Since your contributions are taken out of your paycheck before it is taxed, the net effect on payday not the same. In fact, I demonstrated this to myself pretty recently. I decided to up my contribution to my Health Savings Account (HSA), which is pre-tax money like the 401(k), by $30/paycheck. That seems like a significant dent, especially if you’ve been budgeting tightly. But when the direct deposit hit my checking account, it was less than a $20 difference.
Once again, there is no clear cut rule here and it largely depends on your situation. Bringing your 401(k) contribution to 10% is a good start though if you’re unsure.
- Log in to your 401(k) account
- Increase your contribution to 10% of your gross salary
- Double-check that you’ve got this money going into a low-cost fund. Target retirement accounts are great, but make sure that the expense ratio is less than 0.5%