Should Your 401K Contributions Be Flat or Interest?
When you start a new job with an employer that sponsors 401 (k) plans, you are usually given the option to contribute a portion of your monthly income, either as a fixed dollar amount or as a fixed percentage. But which is better? Here’s a look at the difference in your long-term savings, both at a fixed rate and at an interest rate.
In any case, take the opportunity to recruit employees
Regardless of whether you go with a fixed dollar or percentage fee, try to maximize matching your contributions to any employer of 401 (k), 403 (b) or 457 (b). Not every company does this, but some offer dollar-to-dollar ratios up to a certain amount (for example, $ 5,000 per year), while others may match a specific percentage, for example 50% or 100%, of your contributions up to a certain percentage, or number.
Either way, finding an employer is the best way to save money on retirement in the long run. Your employer will (potentially) double your investment retirement contributions at no cost to you, which will grow exponentially over time thanks to compound interest . This is a tax write-off for the company, so you both win the deal.
This is why financial advisors recommend that you contribute at least enough to reap the full benefits of your employer. Otherwise, they recommend contributing 15-20% of your total income (in an ideal world, of course).
How Fixed Contributions Work
A fixed dollar contribution (or flat rate) works well if you have a fixed budget and very little wiggle room for surprises. You will know exactly how much you pay each month (or even years) and can plan accordingly. You can also ensure that your contributions are fully depleted by dividing the $ 19,500 annual contribution limit by the number of paychecks you receive.
Back side? Well, your income can easily change if you get promoted or take on a new position. In addition, there is no maximum cap on contributions , and the IRS can easily increase the cap in a specific year. In general, the danger here lies in the “set and forget” mentality, in which you forget to update your contributions to reflect the rise in wages. It will then be tempting to reduce your investment as soon as you start making more money.
How interest payments work
Generally, using the interest rate option is better for long-term savings as you never have to worry about losing positions on your contributions. There’s a bit of psychology here too – if you automatically contribute, say, 10%, no matter what, you won’t be tempted to decrease it every time you get promoted, which often happens every year or so. , for some of the staff. And for any increase in income, you are more likely to outpace the fixed dollar contributions in your 401 (k) if you stick to that fixed percentage consistently.