When contributing to your 401(k) go way beyond company match

Dear Pete: 

I’m worried about retirement. I’m 30 and earn about $70,000 a year. I max out my 401(k) contributions at 4%. With the 4% I contribute, and the 4% my employer matches, that doesn’t seem like enough to retire on. My account only has about $12,000 in it. What do I do? — Roy, Fort Worth

Dear Roy: I have to give you credit, Roy. I see your situation quite frequently, but very rarely does a person realize what sort of trouble they’re in when they’re in it. Based on the information you provided me, if you maintain your current contribution strategy, your 401(k) will provide you with approximately $1,170 per month in retirement income in today’s dollars, at age 67. That’s definitely not enough money to retire on.

We need to clear up a major misconception that both you, and a large amount of the American public, have hung your hat on: The match is not the max.

Repeat after me: The match is not the max; the match is not the max; the match is not the max.

Somehow  people have started believing they could only contribute to their retirement plan up to the employer match. For instance, Roy, you believe you can only contribute $2,800 to your 401(k) each year, based on your employer matching 100% of the first 4% you contribute. That’s very, very wrong. You can contribute $18,000 this year ($24,000 if you're 50 or older). And since your employer does match your first 4%, a total of $20,800 can flow into your 401(k) this year. As it stands now, your contributions combined with your employer’s contributions equal $5,600 per year.

How to pay yourself a salary when your income is sporadic

You are not alone in your belief that you’re maxing out your 401(k).  The retirement plan industry has gotten themselves into a bind in regards to communicating the importance of “hitting the match.”  The problem began in the 1980s when pensions (defined benefit plans) began to fall out of favor with employers. In order for people to be able to retire without a pension, they needed to defer and contribute their own income into defined contribution style retirement plans. This was a culture shock. Prior to the beginning of the end of pensions, employees didn’t have much responsibility for the success of their retirement. The match has been used to incentivize people to participate and fund their own retirement. Unfortunately, many folks have simply heard “contribute up to the match.”

It would be incredibly difficult to retire by only hitting the company match, if the company match is equal to the national average (from 2.7% to 4.7%). Most studies suggest a person must set aside 12% to 15% of their income throughout their career, which includes the match, in order to have a successful retirement. Roy, you are only setting aside 8% of your income (4% from you plus 4% from your employer). If you were to increase your contribution to 8%, then the total is 12%, which puts you into range for a successful retirement.

Increasing your contributions would change your income projections from $1,170 per month in today’s dollars to $1,665 per month. By no means does that solve your problem, but it’s a start.

From the moment you finish employee orientation at your first job, you’re on a mission to break your dependency on your income, so that you can stop working someday. Trust me, I know how ridiculous that sounds. Your income leads to expenses, and those expenses lead to a dependency on income. To stop working, you must break your dependency on your work income. You can achieve that by consistently deferring more and more income into your retirement plan. You kill two birds with one stone. You will accumulate assets that can create an income stream to replace your work income. And more important, by restricting your access to your deferred income, you will break your dependency on that income.

Don't confuse 'saving' with 'not spending'

When you defer 8% of your income, you live on 92% of your income. Your goal is to increase the 8% and decrease the 92%. That’s how you’ll be able to retire. Not by having a bunch of money, but instead, by not needing a bunch of money.

The temptation to throw your hands up and not contribute what you should to your 401(k) is intense. In the next 30 seconds you could list 10 reasons why you can’t do what you need to do. However, it behooves you to find the reasons why you should contribute the proper amount. If you don’t fund your retirement properly soon, you will reach a point of no return. Action begins to address your problem. Inaction seals your fate.

The match is not the max.

Peter Dunn is an author, speaker and radio host. Have a question about money for Pete the Planner? Email him at AskPete@petetheplanner.com