Decide HOW MUCH to Invest each Pay Period

Investing in a 401k plan requires you decide how much to invest in your self directed plan.  Because of the tax consequences you should make that decision carefully.  The money you invest is not easy to get before the age of 59 1/2.

In most 401k plans your company will invest whatever amount you tell them into your 401k plan.   This is done BEFORE taxes.  What that means is that you will NOT have to pay income tax on the money you put in your 401k plan IN THE YEAR IT WAS EARNED.  You will eventually pay taxes on the money when you withdraw it from the plan, usually after age 59 1/2.   The assumption is that you will be earning less per year after you retire and therefore your tax bracket will be lower allowing you in general to pay less in taxes.  However, Congress changes tax brackets and laws all the time so nothing is for certain.

Your 401k contribution (that's what they call the money from your pay that you invest each period) should be a portion of your "discretionary" income.  Discretionary income is the money left over from your take-home pay AFTER you have paid the absolutely essential bills.  This usually includes mortgages, credit card debt, insurance premiums, food, etc.  It should NOT be the payments on your toys and extravagant life style.  If you think you have no discretionary income then you are wasting money.  Separate what you really need each month from what you think you need.

Once you know how much discretionary income you have you are ready to decide how much of that amount you want to invest in your retirement.  So, here are the steps:

• Determine your discretionary income.  Every paycheck is divided into two parts:
• The expenses you MUST pay like mortgage, insurance and food.
• The expenses you CHOSE to pay like going to the movies, playing golf, or getting a massage.
• If you subtract the amount you MUST pay from your take-home pay you have the "discretionary" amount from which you can save for retirement. 
• Decide how much of your discretionary income to invest in your retirement. 
  
• Does your employer offer matching contributions?  If your employer offers a matching program you want to invest enough to make sure you get 100% of their matching contribution.
• An employer's matching contribution is company money contributed to your 401k account.  That's a good thing.  Get all of it you can.
• Each matching plan is different so ask your employer to explain it to you.  A common matching plan is "dollar for dollar" up to a maximum percentage of your salary, usually around 5%.
• So, if you make $50,000 your employer will contribute a maximum of $2,500 which is 5% of $50,000.
• But you must also contribute a minimum of $2,500 to your 401k from your salary in order to get these matching contributions.
• Think about, if you do this then your earn %100 on your $2,500 in a year.  You can't do that anywhere else so your dumb not to contribute this amount per year.
• So, first calculation is to determine the amount you must contribute to receive %100 of your employer's matching contributions.
• Five percent is actually not very much when it comes to saving for retirement so you might want to increase the amount.