With a few simple tips you can start to make the most out of your defined contribution plan.
Tip 1: Budget
Every solid retirement plan starts with a concrete budget. Budgeting allows you to determine the amount of money you can contribute and save inside and outside of your retirement plan. Budget calculators are a useful way to determine your expendable monthly income and the amount you have available for savings. The amount you contribute to your 401(k) plan is largely dependent on your available savings.
The percentage you contribute to your 401(k) can be loosely determined by age. According to Linda Gadkowski of Beacon Financial Planning, in your 20s you should contribute 10 percent of your income. In your 30s, contribute 15 percent of your income toward retirement, and in your 40s, around 20 percent. However, if possible, you should always contribute the maximum amount allowed by the Internal Revenue Service.
Tip 2: Get a full match
To make sure you’re getting as much out of your 401(k) as possible, get the full match. Employer 401(k) plans typically contribute 50 cents of every dollar you contribute, up to 6 percent of your income. To get the full match, you should contribute at least the percentage that your employer is contributing. For example, if you make $50,000 a year and your employer is contributing 50 cents of every dollar up to 6 percent of your income, it will contribute $1,500. You will contribute the full 6 percent of your income, which is $3,000.
However, contributing more than the match is always a good idea for extra savings and tax breaks. See how much money you’ll save in your 401(k) plan with our 401(k) savings calculator.
Tip 3: Max out your 401(k)
To reduce your income taxes and save more money, max out your 401(k). The IRS determines the maximum amount of money you can contribute to your 401(k) on an annual basis. For 2012, the maximum is $17,000.
Contributing the maximum amount of money to your 401(k) reduces federal income taxes and most state taxes. If you make $50,000 a year and contribute the $17,000 maximum, you’ll only be taxed on federal income for $33,000. State income taxes vary.
If you’re 50 or older, you are allowed a catch-up contribution of an additional $5,500 per year.