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Getting a Raise? Up Your 401(k) Contribution a Percentage Point

By JLP | April 26, 2011

Let’s say you make $75,000 per year and you are saving 10% in your 401(k). Now let’s say you get a 5% raise, which puts your new annual income at $78,750. Now, before you go make a budget based on your new income, I want you consider increasing your 401(k) contribution percentage by 1% to 11%. To see why, take a look at the graphic below, which shows three scenarios. The first column is the current income of $75,000 and a 10% contribution to the 401(k). The next two columns are at the new pay level. The second column shows what happens if the 401(k) contribution stays at 10% and the third column shows what happens if you raise it to 11%.

By raising the contribution percentage to 11%, you’ll accomplish:

1. Raising your contributions by $1,163 per year instead of just $375.

2. Your Federal income tax* will only go up $388 instead of $506.

3. You’ll still have a net income increase (after taxes AND 401(k) contributions of $2,200 over your previous income.

It’s amazing what a difference 1% makes. Sure, you could keep your contributions at the 10% level and still increase the dollar value of your contributions by $375 per year. But, by increasing the percentage amount by 1%, you’re taking advantage of the raise and bringing down your income tax liability and STILL bringing home close to $200 more per month. It’s a win-win situation.

That said, it’s VERY IMPORTANT that you make the changes to your 401(k) as soon as you find our about your raise. Otherwise, you run the risk of getting too comfortable (or dependent) with your new income and then it will be that much harder to increase your contribution percentage. That additional contribution amount could mean an additional $57,000 to your retirement plan in 25 years (assuming an 8% rate of return and not assuming future contribution increases).

This is how we build wealth.

* Based on 2010’s income tax brackets, standard deduction, exemptions, and the child tax credit (assuming a family of four).

Topics: 401(k), Retirement Planning | 5 Comments »


5 Responses to “Getting a Raise? Up Your 401(k) Contribution a Percentage Point”

  1. Money Beagle Says:
    April 26th, 2011 at 11:57 am

    You know, I’ve been planning on this strategy for the last couple of years but they’ve suspended raises for the last two years. Still anxious to give it a shot later this year (hopefully)!

  2. JLP Says:
    April 26th, 2011 at 12:02 pm

    I just upped my wife’s 401(k) contribution a percentage point this morning. I upped it two percentage points earlier this year. We had been contributing the maximum until we bought our house and life got more expensive. Now we’re starting to build the percentage back up again. We’re close to the max now.

  3. John Says:
    April 26th, 2011 at 4:19 pm

    Before we had a 401k at work, I would use that strategy to add to my mortgae payment. It became a forced savings and I never missed the money. Great Advice!

  4. BG Says:
    April 26th, 2011 at 4:42 pm

    I completely agree with this, might want to look at going to 12% too…

    Until you are maxing out the 401k (which I’m not doing yet either) — all income increases are probably better served to hitting that goal.

  5. JLP Says:
    April 26th, 2011 at 4:45 pm

    BG,

    You’re probably right. However, I think it’s also good to have some balance in life. What’s the point in working hard and getting raises if you can’t enjoy it? But…you make a good point. Going to 12% wouldn’t be a bad idea amd would still leave a little for lifestyle.

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