Section III-A - Lesson 3
Your 401k Contribution - Determining The Optimum Amount
If the 401k rules allowed us unrestricted access to our balance it would be easy to decide how much we should try to contribute, and that would be either the maximum allowed by law, or whatever lesser amount that suited our budget.
But the fact of the matter is that we don't have easy access to our 401k money, and even though we could get our hands on some of this money if we absolutely had to, it's to our benefit to follow the rules and leave it alone.
This is why we need a second investment account - a regular money, non-401k account where we can save and invest for our immediate needs. This is an account we can access anytime we want, for emergencies or for anything else. It's essential that we set up such a regular investment account so we'll have some money we can put our hands on, and we discuss this in Section IV about investing your regular money.
But let's get back to your 401k. To determine our optimum contribution to the 401k we want to reach a happy medium between the amount we want to save for the regular money account and the amount we save for the 401k. This is really fairly easy.
In our book, Financial Independence 101 (FI101-The Book), I suggest that you save a total of 12%, split pretty much evenly between these two accounts.
Your optimum contribution to the 401k will be a percentage that takes complete advantage of any company match, and still leaves roughly half of the total 12% available to your regular money account. If the company match was 50% to a maximum of 3%, it would mean that by contributing 6% of salary we could capture the full 3% maximum match and still have 6% of salary available for use with our regular investment account. We would wind up with a total of 9% working for us in our 401k. This is excellent.
If, instead, the company match was 100% to a total of 5%, it would mean that by contributing just 5% of salary we could capture the full 5% maximum match for a total of 10% working for us in our 401k. This would leave not 6%, but 7% of salary available for use with our regular investment account. This is even better.
But if the company match is only 25% to a maximum of 2%, you'll have to contribute 8% of salary to capture the maximum 2% company match (if you choose to do so). This would leave you only 4% instead of 6% to direct to your regular money account, unless you choose to make this 6% anyway, and thus increase your total savings to 14%.
If you have no company match whatsoever, your decision is easy: split 50/50 between your two accounts.
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