Change The Way You Invest, Change The Way You Save

What If I Increase My 401(k) Contribution By 1%?

I was 23 years young and I was working my first “real” job (post-college). I still remember the day when my Manager dropped the big binder on my desk labelled “Benefits.” Once I selected my health insurance (hardly knowing what a deductible is), I shuffled through a section titled “401(k).”

I knew the gist of what a 401(k) is,  but I wasn’t sure how it operated. To make matters worse, I’m pretty sure it was written in Chinese. The entire experience was overwhelming.

I was asked what I wanted to invest in, what my risk-tolerance is and when I wanted to retire. I remember thinking, “This is my first day of working and they’re already asking when I want to leave? How does tomorrow sound!?”

Once I filled-in the required fields, there was one last section: Contributions.

What percentage of my paycheck do I want to contribute towards my 401(k)? In other words, what amount of money can I give up now, so that I will have money when I stop working?

Yikes! What a tough question. I don’t want to give up anything now. That’s so un-American!

Without doing any math and without looking at any budget, I concluded that I could sacrifice 3%. How did I settle on 3%? Easy. It’s in the middle of 1% and 5%.

1% felt too low and 5% seemed too high.

This was an extremely irrational justification. If I actually did the math, I was concerned about losing $28 each month. At the same time, I was nonchalantly dropping $400 each month at the bars.

What I’m trying to say is that I wish I would’ve contributed more. Contributing an additional 1% to my 401(k) would NOT have changed my current standard of living, but it would drastically affect my future standard of living.

If you continue reading, I’ll do the math and tell you exactly how much.

How Much Will a 1% Increase of 401(k) Contributions Impact my Retirement Savings?

A lot.

In order to do the math, there are a few assumptions that must be made. We will name our subject: Jack.

Jack is 25 years old and earns $52,000 per year. This breaks down to $2000 per pay-period because he gets paid bi-weekly (26 pay periods).  Jack’s employer matches 100%, up to 4%, and he is receiving a raise of 3% each year. Because Jack has decided to invest in the stock market, he expects an average annual return of 8%. Lastly, Jack would like to retire at the age of 65.

100% Match

1% Contribution (compared to no contribution)

  • Effect to paycheck = $14
  • Impact on retirement savings = $399,793 compared to $0

2% Contribution (compared to 1% contribution)

  • Effect to paycheck = $14
  • Impact on retirement savings = $799,539 compared to $399,793

3% Contribution (compared to 2% contribution)

  • Effect to paycheck = $14
  • Impact on retirement savings = $1,199,329 compared to $799,539

4% Contribution (compared to 3% contribution)

  • Effect to paycheck = $14
  • Impact on retirement savings = $1,599,093 compared to $1,199,329

Don’t Understand These Numbers?

For every 1% increase in 401(k) contributions, Jack will have $14 less in each paycheck, but will have roughly $400,000 MORE in retirement savings! If Jack goes from contributing nothing to contributing 4%, he will receive $56 less each pay-period, but he will accumulate roughly $1.6 Million by the time he is 65.

So…if I asked YOU to save $112 each month, do you think YOU could do it? What if I told you that, by doing so, YOU would easily become a millionaire?

It’s pretty enticing, isn’t it?

But…

What if Your Employer Does NOT Match Your Contributions?

Well, the first thing you should do is smack whoever is in-charge and ask, “B*tch, why you ain’t matchin’ this $h!t?”

I am not going to argue whether you should contribute to a 401(k), an IRA or a Roth IRA. They are all extremely useful and I could make a strong argument for each. In order to be best prepared for any tax environment, you should probably have all three. But, since this article is already focused on 401(k) contributions, let’s stick with that.

No Match

1% Contribution (compared to no contribution)

  • Effect on paycheck = $14
  • Impact on retirement savings = $199,896 compared to $0

2% Contribution (compared to 1% contribution)

  • Effect on paycheck = $14
  • Impact on retirement savings = $399,769 compared to $199,896

3% Contribution (compared to 2% contribution)

  • Effect on paycheck = $14
  • Impact on retirement savings = $599,665 compared to $399,769

4% Contribution (compared to 3% contribution)

  • Effect on paycheck = $14
  • Impact on retirement savings = $799,547 compared to $599,665

What Do These Numbers Mean?

By removing the employer match, the effect on Jack’s bi-weekly paycheck is going to be the same. For every 1% increase of contributions, Jack will have $14 less in each paycheck. This equates to roughly $28/month and $364 annually. But, by setting aside $14 each paycheck, Jack is able to have an additional $200,000 in retirement savings.

Summary

Whether you are receiving a match from your employer on your 401(k) contributions, I would still recommend contributing as much money as you can. A very small sacrifice NOW will have a very BIG impact later. In the above scenario, a sacrifice of $14 every 2 weeks, will add an additional $200,000 to $400,000 to your nest egg, come age 65.

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9 thoughts on “What If I Increase My 401(k) Contribution By 1%?

    • You’re absolutely right. Liz Weston wrote a nice article recently comparing how a small amount saved at a younger age is MORE than a large amount saved at an older age.

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  2. Goes to show the power of compounding and time. When taken together, it can yield amazing results that come to fruition later in life. I’m thankful I invested when younger, and just wish I had been even more aggressive about it. Never too late to make improvements.

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  4. Pingback: Why Does It Feel Like I’m Saving When There’s No Money In My Savings Account? | Fat Free Personal Finance

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  6. Pingback: Housing Price Graphics, The President’s Finances, and Retirement Contributions - BuzzNice.info | BuzzNice.info

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