Today’s question comes from Javier in Gainesville, FL…
“My question is about my 401k. Let’s say I get a raise at work, and I want to put it into my 401k. But I want to make sure I keep the same net income that I currently take home.
I figured the 401k already will automatically take more once the raise is applied because it’s a percentage of my gross amount.
So let’s say the raise is 5%. How much should I increase my 401k contributions by, so that my net income is relatively the same after the deduction. Thank you in advance.”
Matt & Joel’s response: First off, I love that you’re not content to just leave your investment amount static. You’re wanting to increase your overall savings rate and put away even more, which is awesome!
The short answer is: You’ll have to do some reverse calculations to figure out your new 401k contribution percentage. It’s highly unlikely that you’ll be able to reach the same exact paycheck amount, but you can get close!
Here’s how…
Increasing 401k percentage
Just because you get a 5% raise, it doesn’t mean you can increase your 401k contribution by 5%. The numbers don’t work like that.
You need to manually break down your paychecks, and do a bit of trial and error to arrive at the right percentage.
For example, let’s say your bi-weekly check is currently $2,000 and you contribute 13% to your 401k. That’s $260 going into your 401k every 2 weeks. Awesome…
But now after that 5% raise, your bi-weekly check is up to $2,100. To figure out how to get back to the $1,740 post-contribution check, you need to play around with the 401k percentage and figure out what gets you back to your previous take-home pay.
In this scenario, raising your contribution percentage to 17% will net you $1,743. That’s pretty close!
All in all, that’s a 4% increase to your 401k contribution, even though the raise was 5%.
Enjoying your raise
We love that you’re trying to bolster your retirement savings in the right direction and working to keep lifestyle creep in check.
But, don’t feel that you have to invest the entire raise amount. It’s OK to treat yourself a little and spend a bit more money as you make more.
Our typical advice is to invest 50% of a pay raise. That gives you more take-home pay to enjoy for discretionary spending. And to help combat rising prices. Or to throw towards other shorter term financial goals you might have. Like saving for a vacation or even giving to charity.
If you’re already crushing it and have a 20%+ savings rate, it’s ok to take your foot off the gas a little. Enjoy life and find that balance of saving vs. spending.
Here’s how your savings rate impacts the years it might take for you to retire 👇👇👇
For folks who are behind on retirement savings, it’s definitely smarter to try and invest that entire raise if you can. Catching up down the road is harder, so windfalls and raises should be meticulously saved.
Roth 401k
By the way – something else worth considering is contributing to the Roth version of your 401k. (if your company allows this option)
Contributing to a Roth 401k can diversify your investment buckets and give you more flexible options in terms of future tax exposure.
In retirement, it’s really handy to have multiple account options to pull from. Because nobody knows precisely what the tax landscape will be in the future.
Plus, your employer might even match your Roth contributions with Roth dollars thanks to the Secure Act 2.0. They used to match your post-tax dollars with pre-tax ones. But that’s not the rule anymore – so check with your employer!
You’d indeed be taking on a larger tax burden in the given year, hence the suggestion to not raise your contribution % much if at all in 2024 if you decide to opt for the Roth 401k option. But Roth accounts are always worth considering because you’ll be locking in significant future tax benefits!
The Bottom Line:
Whenever a raise hits, it’s the perfect time to invest more. But blindly changing your 401k percentage will affect the amount you’re used to taking home with each paycheck. So run multiple calculations and arrive at what you feel you can live on.
Remember, the money you earn should be both enjoyed and saved. It’s OK if you want to invest a smaller amount and treat yourself to some small lifestyle upgrades. In any case, you’re still saving more for retirement automatically based on this raise. Keep up the good work!
For the full version of this discussion, check out Podcast Episode #859 (it’s the 1st question in the episode)
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