A lot of times we are given a final target amount to save for retirement. Well how about if you set up your monthly budget to save a fixed percentage of your income. Then the question is what percentage should you save and also where that savings should be/
Well the answer depends upon where you are in your financial journey and also what the savings is intended to be used for. If you are still in debt then I would suggest having an emergency fund and paying off all of your debt prior to saving for the future. The only exception to this is if you have had to use your emergency fund for any reason and drawn it down. If you have drawn down your emergency fund then you should make your minimum payments and rebuild your emergency fund back to your required balance.
If you after you have paid off all your debt except for your mortgage then there are many schools of thought. Dave Ramsey’s baby steps say you should save 15% in your 401K once you have saved up to 6 months worth of income. What percent should you save when you are building to 6 months worth of income? The answer is as much as you can to get to that mark as soon as you can.
There is a huge difference in saving in a 401K and saving for an emergency fund. How much you should save is dependant upon how much you want at your disposal. Most company’s 401K plans has a match of on average 50% of up to 6% of salary. So you are getting 3% from the company match. So in theory you would only need to save 12% f your income if you received a 3% match and also these dollars are pretax so you are saving this amount before taxes and thus reducing your taxable income.
Imagine you make $1,500 every two weeks. If you save 12% in your 401K you save $180 and your hypothetical withholding at 25% would be $330. Now if you saved 12% in after tax dollars, your withholding would be $375 and you would save $135. So as you can see from a tax perspective you are saving more and paying less in taxes when you save in a 401K, but the drawback is you do not have access to your money in case of an emergency without a penalty. If you earn a 3% rate of return (money market rates) on those funds, then over 20 years you save approximately $15,000 more in a 401K than saving after tax dollars.
As you can see from calculation you should weigh your need for having savings at your disposal with the long term benefit of paying yourself more than you pay the government. You should save whatever you can comfortably each month and calculate what you would like to save for non retirement investments and then save the remainder in your 401K up to the IRS allowable limit.
Good luck and happy saving.
