When it comes to the question of how much you should contribute to your 401(k) account, the best answer is usually as much as you can. But that amount may differ based on your age and current financial circumstances as well as the annual 401(k) contribution limit.

Here’s what to consider when you’re determining how much to contribute to your 401(k).

3 key factors affecting your 401(k) contribution

If you ask a financial advisor how much you should contribute to your 401(k), many recommend deferring between 10 and 15 percent of your salary. But the percentage that’s right for you depends on the following three factors:

  1. Your age: The earlier you start contributing, the better, due to the compounding effect of money. The fewer years you have between now and when you plan to start tapping into your 401(k) in retirement, the higher the percentage of your salary you should contribute for the years you remain in the workforce.
  2. How much you can afford to contribute: This consideration is particularly important if you are responsible for fixed payments such as student loans, car loans, a mortgage or rent, child or doggie day care or perhaps even medical bills. You’ll need to be able to set aside money after your necessary expenses.
  3. Your retirement goals: You’ll want to consider what kind of retirement you want. Having a realistic retirement goal is important and can impact your contribution decision. Maintaining your current standard of living after retiring requires about 80 percent of your pre-retirement income. If you want a grander retirement, you’ll need to save more.

How much can you contribute to a 401(k)?

The IRS places contribution limits on 401(k)s: For 2023, the contribution limit is $22,500, with an additional $7,500 allowed in catch-up contributions for workers who are age 50 or older.

How soon you are eligible to join your employer’s 401(k) depends on how the plan has been set up. Some plans allow employees to join on the first day of employment, but other plans may require up to a one-year waiting period. If your employer’s plan has a waiting period, consider setting up an IRA so that you can start saving for retirement right away.

Employer matching contributions

If your employer provides matching contributions, you should try to contribute at least as much as the company matches, since this is basically “free money.” For employees who work at organizations that provide a 401(k) match, the IRS limits noted above do not include employers’ contributions.

A common match formula is 50 cents for each dollar saved, up to 6 percent of pay. So if an employee contributes 6 percent and the employer contributes 3 percent, the employee is actually saving a total of 9 percent per year. Some employers offer an even greater match.

If your employer does not offer a match, some employees have found it to be a smart move to first contribute the maximum to an IRA, and only then begin contributions to their company’s 401(k).

Pay tax now or later when contributing to your 401(k)

When you sign up with your employer’s 401(k), you will need to decide if your contributions will be pre-tax or after-tax, that is, whether they go into a traditional 401(k) or a Roth 401(k), if your employer offers a Roth option.

Saving on a pre-tax basis means you are deferring the tax liability on your contribution until after you retire. As an example, a worker aged 50-plus in the 12 percent tax bracket (married filing jointly) with $80,000 in taxable income who defers the maximum for 2023 – $30,000 – will reduce their tax bill by $3,600.

Saving for retirement on an after-tax basis in a Roth 401(k) means you pay taxes on your contributions now at your current tax rate. When you access the money after age 59 ½ , the withdrawals will be tax-free as long as funds have been in the account for a minimum of five tax years.

If your employer plan allows it, you can take advantage of both types of contributions to diversify your tax position at retirement.

When determining your contribution percentage, consider automatic boosts

In 2021, the average employee contribution to a Vanguard 401(k) plan was 7.3 percent of pay, according to Vanguard 401(k). Meanwhile, only 23 percent of 401(k) participants saved more than 10 percent of their salary for retirement.

If you can’t afford to contribute much initially, many employers will allow you to increase your contribution percentage automatically each year (up to a maximum of 10 percent), which may be a more comfortable and gradual way to increase your contribution amount.

A 401(k) can be one of your best tools for creating a secure retirement. But you may want to also consider some retirement investing alternatives.

Bottom line

Contributing to a 401(k) account can be one of the best investments you make for your future. Even if you cannot contribute the maximum amount, starting as early as you can and being consistent with contributions throughout your career will ensure smooth sailing into retirement.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.