How to Adjust Your 401(k) Contribution Percentages

Quick answer

• Review your 401(k) contribution percentage at least annually or when your financial situation changes.
• Aim to contribute enough to get the full employer match; it’s free money.
• Consider increasing your contribution as your income rises or your debts decrease.
• Adjust contributions based on your retirement goals and current age.
• Be aware of annual IRS contribution limits for 401(k) plans.
• Consult your HR department or plan administrator for specific instructions on making changes.

What to check first (before you invest)

Before you adjust your 401(k) contributions, it’s wise to get a clear picture of your financial landscape. This proactive approach ensures your retirement savings strategy aligns with your overall life goals.

Time horizon

Your time horizon is simply the amount of time you have until you plan to retire. This is a crucial factor because it dictates how aggressively you can afford to invest and how much you need to save. A longer time horizon generally allows for more aggressive investment strategies and a greater reliance on compounding growth. Conversely, a shorter time horizon may require a more conservative approach and a higher savings rate.

Risk tolerance

Risk tolerance refers to your comfort level with the possibility of losing money on your investments in exchange for potentially higher returns. Understanding this helps you choose investment options within your 401(k) that won’t cause undue stress. If market downturns make you anxious, you might prefer more stable, lower-return investments. If you can stomach volatility for the potential of greater growth, you might opt for more aggressive funds.

Emergency fund

An adequate emergency fund is a non-negotiable prerequisite to maximizing retirement contributions. This fund, typically holding 3-6 months of living expenses in a readily accessible account, prevents you from needing to tap into your retirement savings for unexpected costs like job loss or medical bills. If your emergency fund is insufficient, prioritize building it before significantly increasing your 401(k) contributions beyond the employer match.

Fees and tax impact

Every investment within your 401(k) has associated fees, such as expense ratios for mutual funds. High fees can significantly erode your returns over time. Similarly, understanding the tax implications of your contributions is important. While traditional 401(k) contributions are pre-tax, Roth 401(k) contributions are after-tax but grow and are withdrawn tax-free in retirement. Always check the specific fee structure of your plan and understand the tax treatment of your chosen contribution type.

Account type (401(k), IRA, brokerage)

Your 401(k) is a workplace retirement plan, often with an employer match. Other retirement savings vehicles like Individual Retirement Arrangements (IRAs) – Traditional or Roth – offer different contribution limits and tax benefits. Brokerage accounts are for non-retirement investing. Ensure you’re maximizing tax-advantaged accounts like your 401(k) and IRA before heavily funding taxable brokerage accounts for retirement, as these offer the greatest tax efficiencies.

Step-by-step (simple workflow)

Adjusting your 401(k) contributions is a straightforward process that can significantly impact your long-term financial well-being. Follow these steps to ensure you’re on the right track.

1. Assess your current contribution rate:

• What to do: Log into your 401(k) provider’s website or check your pay stub to find your current contribution percentage.
• What “good” looks like: You know your current percentage and understand how it translates to your take-home pay.
• A common mistake and how to avoid it: Not knowing your current contribution rate. Avoid this by making it a habit to review your benefits information at least once a year.

2. Verify your employer’s match:

• What to do: Check your plan documents or ask your HR department about the employer match formula (e.g., “50% match on the first 6% of your salary”).
• What “good” looks like: You contribute at least enough to capture the full employer match.
• A common mistake and how to avoid it: Not contributing enough to get the full match, leaving free money on the table. Avoid this by prioritizing matching contributions in your savings strategy.

3. Review your retirement goals:

• What to do: Consider your desired retirement age, lifestyle, and estimated expenses in retirement. Use online retirement calculators to get a general idea of how much you might need.
• What “good” looks like: You have a general target for your retirement savings and a rough idea of your required savings rate.
• A common mistake and how to avoid it: Not having any retirement goals, leading to insufficient savings. Avoid this by setting realistic, actionable goals.

4. Evaluate your current income and expenses:

• What to do: Look at your budget. Have you received a raise? Have your expenses decreased (e.g., paid off a car loan)?
• What “good” looks like: You have a clear understanding of your cash flow and identify areas where you can potentially increase savings.
• A common mistake and how to avoid it: Increasing contributions without considering your current budget, leading to financial strain. Avoid this by ensuring your increased contribution doesn’t jeopardize your ability to cover essential expenses.

5. Determine your new target contribution percentage:

• What to do: Based on your goals and financial situation, decide on a new percentage. This might be increasing it by 1-2% or aiming to reach the IRS maximum if financially feasible.
• What “good” looks like: You have a specific, achievable percentage in mind.
• A common mistake and how to avoid it: Setting an unrealistically high contribution percentage that strains your budget. Avoid this by making gradual increases and testing them in your budget.

6. Check IRS contribution limits:

• What to do: Research the current year’s IRS contribution limits for 401(k) plans. These limits apply to employee contributions.
• What “good” looks like: You know the current year’s limits and ensure your planned contribution doesn’t exceed them.
• A common mistake and how to avoid it: Exceeding the IRS limit, which can result in penalties or the need to withdraw excess contributions. Avoid this by staying informed about annual IRS limits.

7. Access your 401(k) provider’s portal:

• What to do: Log in to your account on your 401(k) administrator’s website.
• What “good” looks like: You can easily navigate to the section for managing your contributions.
• A common mistake and how to avoid it: Difficulty finding where to make changes. Avoid this by familiarizing yourself with the provider’s platform during a non-urgent time.

8. Initiate the change:

• What to do: Follow the prompts to enter your new desired contribution percentage.
• What “good” looks like: You have successfully submitted your new contribution percentage.
• A common mistake and how to avoid it: Making a typo when entering the percentage. Avoid this by double-checking the number before submitting.

9. Confirm the change:

• What to do: Look for a confirmation screen or email. Check your next pay stub to ensure the new percentage is reflected.
• What “good” looks like: You have received confirmation and your next pay stub shows the updated deduction.
• A common mistake and how to avoid it: Assuming the change was processed without confirmation. Avoid this by actively verifying the update on your pay stub.

10. Rebalance your investments (optional but recommended):

• What to do: If your contribution increase significantly changes your asset allocation, consider rebalancing your investment portfolio within your 401(k).
• What “good” looks like: Your investment mix remains aligned with your risk tolerance and time horizon.
• A common mistake and how to avoid it: Not rebalancing, causing your portfolio to drift from its target allocation. Avoid this by periodically reviewing and adjusting your investment choices.

Risk and diversification (plain language)

Investing for retirement involves understanding and managing risk. Diversification is your primary tool for this, helping to smooth out the ups and downs of the market.

• Don’t put all your eggs in one basket: This is the core idea of diversification. Instead of investing all your money in a single company’s stock or a single type of asset, spread your investments across many different assets.
• Different asset classes behave differently: Stocks, bonds, and real estate, for example, often react to economic events in different ways. When stocks are down, bonds might be up, and vice-versa.
• Example: Stock diversification: Within stocks, diversify by investing in companies of different sizes (large-cap, mid-cap, small-cap), in different industries (tech, healthcare, energy), and in different geographic regions (U.S., international).
• Example: Bond diversification: Diversify bonds by type (government, corporate, municipal), maturity (short-term, long-term), and credit quality (high-yield vs. investment-grade).
• Mutual funds and ETFs are diversified: These investment vehicles pool money from many investors to buy a basket of securities, offering instant diversification. Your 401(k) likely offers various mutual funds.
• Reduces overall portfolio volatility: By spreading risk, diversification aims to reduce the severity of losses when one part of your portfolio performs poorly. It doesn’t eliminate risk entirely, but it can make the ride smoother.
• Doesn’t guarantee profits or prevent losses: Diversification is about managing risk, not eliminating it. Even a well-diversified portfolio can lose value in a broad market downturn.
• Asset allocation is key: Deciding how much of your portfolio to allocate to different asset classes (like stocks vs. bonds) is a critical part of diversification and should align with your risk tolerance and time horizon.

During market drops, it’s crucial to resist the urge to panic sell. Remember that market downturns are a normal part of investing. If your portfolio is well-diversified and aligned with your long-term goals, these periods can be opportunities to buy assets at lower prices. Stick to your investment plan and avoid making emotional decisions.

Common mistakes (and what happens if you ignore them)

| Mistake | What it causes