Personal finance can be overwhelming. There are so many steps, dos and don’ts, and behaviors to adopt. Once in a while it would be nice to have a fail-safe, simple solution[1] to follow to make sure you have enough for retirement.
Maxing out your 401(k) is the single best way to save for retirement, lower your tax implications and spend less, all in one fell swoop.
Does it work for everyone? No. Like any “one size fits all” rule, there are those for whom it won’t fit. Some people don’t have access to a 401(k) (or its nonprofit sister, the 403(b). Some people want to spend too much in retirement to only save $18,000ish a year.
But for the vast majority of Americans who work in a job where they have access to a 401(k)[2], maxing out this retirement savings vehicle makes a lot of sense.
Let’s look at the math.
The hypothetical
We’ll take a hypothetical saver, Meredith. Meredith is fresh out of college, and is 22 years old. She has a new job where she earns $40,000 a year. She has access to a 401(k) and health care benefits. Let’s say she lives in New Hampshire, like me (that means she has no state taxes — good for her).
If she’s paid biweekly, then she’ll bring home $1538.46 gross. Let’s subtract $317.26 for federal taxes, Social Security, and Medicaid, and $50 for subsidized health care premiums (for a single person, the average would be $41.19 a paycheck. I rounded to $50).
That means, after taxes, she’ll bring home $1171.20.
What if she opts in, all in, for her 401(k)? She contributes $692.31 per paycheck, which should be allowed by her company as it’s less than 50% of her gross pay.
Because she’s lowered her federal tax implications by such a large amount, she’ll owe $213.41 in taxes, $50 in health care, and bring home $582.74.
Yes, that is about half of what she was making. And for most people, living on roughly $1150 a month would be very difficult. But, what if she could swing it? She finds a room to rent with some friends, pays $300 in rent per month, drives her beater car, and makes it work.
Eventually, she and her boyfriend get married, he starts working, they get raises[3], and their income rises to $100,000 combined a year. Let’s say, for the sake of our hypothetical argument, that he never contributes a dime to a 401(k). Meredith works for 40 years, and never saves more than $18,000 a year in her 401(k) (for simplicity’s sake). Also, her employer never gives her any type of match. And she never saves in any other vehicle. But she faithfully maxes out her plan each year.
If she works for 40 years and retires at age 62, then with a...