I have posted about this on Twitter a few times recently. I come across people who don’t know how much they should contribute. Some people think they can’t afford to contribute at all and some just don’t know the basics. And let’s be honest, human resources staff will just tell you that you have a 401k. Most of them don’t know the basics either and just refer you to the plan representatives.
I want to make this a quick and basic tutorial. Contributing and lowering your tax liability is easy. What funds to put it in….that’s another topic. Although don’t fear that just yet. If your just getting started then let the 401k plan contributor manage it while you measure their performance and fees.
I decided to use a salary of $75,000 but we could use any salary to make the point. The salary range will change your tax bracket depending on how much you contribute to your 401k.
Example 1:
75k per year salary with bi-weekly paychecks and claiming 0 for Federal and State taxes and no contributions. Combined Federal and State tax liability is $672.52 with $0 dollars going into a 401k. Total take home pay is $52,546.00 after taxes.
Example 2:
75K per salary with bi-weekly paychecks claiming 0 on Federal and State taxes and contributing 8% of base salary into a 401K account which is exempt from Federal, State, and Local taxes.
Combined Federal and State tax liability is $565.89 with $230.77 going into a 401k. After deductions the take home pay is $1,867.28 which is a difference of $154.00 per paycheck. Total take home pay is $48,549.28 and $5,980 into a 401k account.
Conclusion:
Example 1 will allow you to have a larger paycheck but only by $154.00 while paying more in taxes.
Example 2 allows you to save $5980.00 while still taking home $48,549.28 for a grand total of $54,529.28.
By contributing 8% of your 75k a year salary into a 401k you are saving over 2k from being taxed.
Seems like a win-win to me.
Screenshots courtesy of PaycheckCity
I use the free salary calculators at PaycheckCity to analyze my contributions and tax liability. It is a very useful too that can help you decided how much can you afford to save. And if you live paycheck to paycheck, start tracking expenses to see what you can afford. It might be more than you think.
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