What’s the Difference Between Contributing 6% vs. 9% of Your Salary Into Your 401(k)?

 

When you first sign up and enroll in your 401k, you have to decide how much am I going to contribute to this account? And of course, the more you contribute and the better you invest those dollars, the more income you’ll have in retirement. So I want to go through and show you the difference between saving 6% of your salary, versus 9% of your salary. And at the end of this video, I’m going to talk to you about a secret that you can use to have more retirement income in the future from your 401k.

Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, CERTIFIED FINANCIAL PLANNER™ Professional (CFP®) and host of The Retirement Income show.
So we’re gonna look at the time value of money calculator. If you’ve seen some of my other videos, we’ll use this as an exercise to show you the power of compound interest. Einstein called compound interest the eighth wonder of the world. This is one of the fundamental concepts that we must understand if we want to be good at saving and investing our money and becoming more financially free.

So I’m just assuming in this example, we have a zero 401k balance. So we just started a brand new job, I want to say your salary is $100,000 a year, maybe combined, you and your spouse are making $100,000 a year, I just want to show the concept here of saving more and help you to understand and maybe learn to calculate this on your own.

So we’re first saving 6% of our salary, starting with a zero balance inside our 401k, earning 8% annually over a 30 year period. So this assumes you’re 35 years old, going to retire at 65, or maybe 30 retire at 60, or 40 retire at 70. Over a 30 year period, we would have about $679,000 inside of our 401k.

So that means if we put 6000 a year, and this assumes no employer match, I’m just isolating the contribution rate that you make inside your account, so we would put in 6000 a year times 30 years, we put in $180,000, but we end up with 679,000 in our retirement account at the end of 30 years.

Now, if we change this to 9%, so $9,000 per year instead of $6,000 per year, so an extra 3000 over 30 years, that’s an extra 30, 60, 90,000. The difference the extra 90,000 that we put in brings us to over a million dollars inside our 401k. So it’s almost 275,000 or so dollar increase in the ending balance of our 401k, and retiring with a million dollars, of course is going to put you in a more secure position than retiring with 679 there.

So let’s look at this a little bit different. Let’s say you already have $300,000 inside your 401k, and let’s say you’re making, between you and your spouse, you’re making $200,000 per year, a 6% contribution would be $12,000. And let’s say now you only have 20 years before you retire, still earning 8%. 6% of your salary, starting with 300,000, earning 8% over 20 years gives us a future 401k balance of about $1.9 million.

Now, if we save 9%, which is a 50% increase to that savings, we’re not saving 12, we’re saving 18,000 per year. It goes from 1.9 up to 2.2. So almost a $300,000 increase in the ending balance there by only contributing an additional 6000 per year over 20 years, so about 120,000.

So the most powerful element of all when it comes to compound interest is the time period. The more periods we have to compound our interest, the greater the snowball effect. So that’s why we have to start young when we’re saving and investing to give us the best opportunity.

But even when we’re starting late, it doesn’t mean we can’t get there, it just means we need to be a little bit more diligent about our saving. The difference between saving 6% versus 9%, keep in mind, it’s not just those extra dollars that you put into your account, but it’s the compound interest that you’ll earn on those extra dollars, which once we get to retirement of course means more security for our loved ones, more income to enjoy our standard of living, and of course we sleep better at night knowing that we have a more comfortable standard of living in retirement.

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