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Financial Literacy Month: Contribution Strategies for Retirement

by on April 12, 2012

By Meghan Stewart

We’ve spent the first part of our Retirement Roundup for Financial Literacy Month talking about the kinds of retirement accounts you can have. Now the next step is to determine the best way to contribute to your retirement. Experts agree having both an IRA and a 401(k) helps diversify your retirement investment opportunities, so even if you have a 401(k) through your employer, it’s still a good idea to open a private IRA as well.

Once you have both accounts open, determining how to contribute largely depends on how your 401(k) at your job works. Some employers match contributions or at least match contributions up to a certain amount. This means for every dollar you contribute, your employer agrees to contribute money as well. This is typically around 50 cents to a dollar to match every dollar you contribute.

This is basically extra money you can earn for retirement simply by being responsible in contributing. You contribute $1, but your retirement account gets anywhere from $1.50 to $2.00. There is usually a maximum amount your employer has set they will match, but up to that point matching can make a huge impact on increasing the money you have invested.

In this light, it makes sense to contribute as much as possible to your 401(k) up to the match contribution limit of your employer. Once you reach this contribution limit, however, retirement experts recommend dedicating retirement contributions to your IRA instead—up to the yearly contribution limit (either $5,000 if you’re under age 50 or $6,000 if you’re over 50). Any extra money left over can then go to your 401(k), since the contribution limit is much higher so you can invest more each year.

Now, of course your 401(k) contributions are automatically deducted out of your paychecks, so you may be wondering how you manage a split contribution for retirement. The deduction amount is based on a percentage of your income you select to contribute when you select your benefits. So how do you do a dual contribution strategy if the money is going to be taken out automatically throughout the year?

The best thing to do is get out the calculator and do some math to find out what percentage you need to be contributing to reach the max match contribution limit of your employer. You want to select a contribution percentage that at least equals the amount you need to hit the maximum match limit. Then determine how much money you will have in your monthly take-home budget each month to put towards retirement. Calculate what that will be each year. If it’s above $5,000 then you can adjust your contribution percentage on your 401(k). Play around with the numbers until you have the right plan to maximize your retirement contributions.

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