Are your 401(k) contributions keeping up with your salary?

You may still be a few decades away from retirement, but it’s never too soon to ramp up your savings for your life as a retiree. And one of the best ways to do so is to increase your contributions to your 401(k)—or whatever retirement account you have access to—whenever your salary goes up.

You may even see a bigger boost to your salary. U.S. employers gave an average 3.4% raise to their workers in 2022, according to a survey from Willis Towers Watson, a risk management and insurance brokerage company. Of course, your salary increase may be less – or more – than this amount. Either way, a good strategy is to put at least some of that salary boost to work in your 401(k).

Why is it so important to put in as much as you can to your 401(k)? Let’s review the key benefits of this plan:

Tax advantages – By contributing pretax dollars to your 401(k), you can lower your taxable income, and your money can grow on a tax-deferred basis. If you contribute to a Roth 401(k), you put in after-tax dollars, so you don’t get an immediate reduction in your taxes, but your earnings growth and distributions in retirement are generally tax free.

Employer match – If your employer offers a match, you can think of it as almost a bonus in pay. Matching amounts vary among employers. They are commonly structured as 50 cents on the dollar or a dollar-for-dollar match, usually for 3% to 6% of an employee’s salary.

Ease of contributing – You contribute to your 401(k) through payroll deduction – the easiest way to save. And some plans have an automatic “escalation” feature, so you can increase your contributions with just a few clicks on your computer or smartphone.

So, given the various benefits of a 401(k) plan, how much should you contribute each year? You'll want to balance how much you contribute with other goals you may have, like building an emergency fund or paying down debt. A financial advisor can help you with this. And of course, there are limits: in 2023, you can put in up to $22,500 to your 401(k), or $30,000 if you’re 50 or older. In addition, some employers allow you to contribute additional after-tax dollars. Earnings on these after-tax dollars are tax deferred and you may be able to convert them to Roth assets so that future earnings are tax free. You'll have to check with your employer to determine your options.

Strategies for boosting your 401(k) savings

Start with the match – At a minimum, you’ll usually want to contribute enough to your 401(k) to earn your employer’s matching contribution if one is offered.

Work toward saving 10% to 15% (or more) of your income – Everyone's needs are different, but a rule of thumb is to save 10% to 15% of your income toward retirement. If you want a more personalize savings goal, a financial advisor can help determine how much you need to save to achieve the retirement lifestyle you've envisioned. If you're not saving enough today, consider these strategies:

• See if you can increase your savings by 1% of your salary each year.
• Reserve a certain dollar amount or percent of future pay raises, bonuses or financial windfalls to go toward your retirement savings. For instance, promise half of your raise to go to increased retirement contributions, or $500 of your tax refund for next year.
• If your employer offers an auto-escalation capability, make sure to enroll in it.

Beyond your 401(k)

While your 401(k) can and should be a key part of your retirement savings, it likely won’t be the only component. To help further improve your financial situation during your retirement years, you may also want to contribute to other accounts, including these:

• Health savings account (HSA): If you are covered under a high-deductible health plan (HDHP), you can generally contribute to an HSA, which has triple tax advantages: Your contributions are made with pretax dollars, reducing your taxable income for the year; your earnings grow tax free; and your withdrawals are tax free, provided the money is used for qualified medical expenses. And the money in your HSA can be carried over from year to year – you aren’t obligated to “use it or lose it.” Thus, the money could ultimately be used to help pay for qualified health care expenses in your retirement – and these costs typically make up a significant portion of your spending needs as a retiree. In 2023, you can contribute up to $3,850 to an HSA if you have single coverage, or $7,750 for family coverage. And if you’re 55 or older, you can put in an extra $1,000 per year.
   
• IRA: Even with your 401(k), you’re probably also eligible to contribute to a traditional or Roth IRA. For the 2023 tax year, you can put in up to $6,500 to your IRA, or $7,500 if you’re 50 or older. A traditional IRA is typically funded with pretax dollars, so your contributions can lower your taxable income, and your earnings can grow tax deferred. However, the amount of contributions that you can deduct from income can be reduced, and eventually eliminated, based on your ability to access an employer retirement plan and your income level. A Roth IRA is funded with after-tax dollars, but earnings and withdrawals are generally tax free. However, the amount you can contribute to a Roth IRA is reduced, and eventually eliminated, based on your income level. To verify your eligibility, you’ll want to consult with your tax advisor.
   
• Retirement plans for self-employed: If you’re self-employed, or own your own business, you have access to any of several retirement plans, such as an “owner-only” 401(k), a SEP-IRA or a SIMPLE IRA. If you don’t already have such a plan, you may want to consult with your tax and financial advisors to determine which option best meets your needs.
   
• Nonqualified Annuity: If you’ve “maxed out” on your 401(k) and other retirement accounts, and you still have funds to invest, you may want to consider a nonqualified annuity, which can provide guaranteed fixed income during retirement. In fact, you can structure an annuity to provide you with an income stream you can’t outlive. A financial advisor can help you determine if an annuity is appropriate.

Ramp up your retirement savings

Increasing your 401(k) contributions whenever your salary goes up can help you make progress in pursuit of your retirement goals. And it may also pay off to contribute to the other accounts and retirement vehicles available to you. Your financial advisor can review your situation and recommend the right combination of moves for your situation.