In talking to participants in 401(k) Plans in and out of my purview over the years I often hear the comment that one is maxing out contributions to their 401(k) Plan. I’ve found that this term can mean different things and some people may be short-changing themselves when it comes to saving for their retirement.
For 2012 the maximum contribution an individual can contribute to a qualified retirement plan such as a 401(k) is $17,000 (up from $16,500 in 2011). If you are over the age of 50 you can contribute another $5,500. Contributing $17,000 is the true definition of contributing the maximum allowable amount to your 401(k).
The more commonly used definition of “maxing out” is contributing up to the percentage that your employer will contribute on your behalf. According to the Profit Sharing Council of America the average employer contribution is 3% of pay with the most commonly used matching formula of $0.50 of each $1.00 deferred up to a limit of 6% of compensation. While an employee in this case will no longer receive employer contributions on deferrals above 6% of their pay, they are certainly not restricted from contributing more.
Many financial planners will use the 10-15% of pay as a target range of what one should save each year to increase your chances for a secure retirement. In the above example an employee that stops contributions at 6% would be saving 9% when including the employer’s match. For reference, the State ofWisconsin’s Retirement System, one of the more highly-touted public pensions, uses a contribution formula that is around 11-12% of an employee’s annual pay.
When evaluating your retirement savings you should pay extra close attention to not only what your employer is contributing, but also what you are allowed to do.