When contributing to your employer-sponsored plan, you can choose to defer your income by a dollar or a percentage amount. The smart thing to do is to opt for whichever makes you save more.
An automatic deduction from your paycheck is an effective way to save for retirement regularly. When initially enrolling in a 401(k), 403(b), 457 or a savings incentive match plan for employees, you elect how much, in dollar or percentage terms, you want to contribute each pay period.
Generally, the wiser decision is to choose the fixed percentage, because if you get a raise, your contribution automatically increases. You never have to worry about changing it during your time at this company.
For example, John starts a job earning $50,000 annually and decides to contribute 10 percent to his retirement plan. That?s $5,000 per year. After a year, he gets a raise. Now he earns $55,000. The amount that goes into his retirement plan automatically increases to $5,500 annually.
If John selects a fixed amount, the good news is that he?s at least saving. However, he saves $500 less per year. The gap widens if his income increases substantially over time unless he is diligent enough to change his contribution every time he gets a raise.
There?s no universal rule for what percentage you should save, but you should at least contribute up to the percentage of your employer?s match. And according to Fidelity, those who saved more than $1 million in their 401(k)s on average deferred about 14 percent of their pay.
Choosing the fixed dollar amount has its benefit. You can spare yourself some math if you want to contribute the maximum to your 401(k). Simply divide the limit by the number of total yearly paychecks.
Let?s assume Susan, 45, wants to give her retirement savings a boost by contributing the limit, which is $18,000 in 2015 and $24,000 for those over 50. She is paid 24 times per year. This equals a fixed dollar amount of $750 per paycheck. She can easily adjust the amount whenever contribution limits increase.
Another example of where a fixed dollar amount works is when a person contributes monthly to his or her individual retirement account. Most IRA custodians allow you to transfer a certain amount from a bank account into the IRA every month.
The traditional and Roth IRA contribution limits are $5,500. If you are over 50, you can make additional catch-up contributions of $1,000. Therefore, you can save up to $458.33 a month or $541.66 if you qualify for the catch-up.