So you’ve decided to start saving for the future by setting up your first retirement account. Give yourself a pat on the back — it was a smart decision. You’re making your future a priority, and, depending on when you start contributing, time and compound interest are working in your favor.
Your work is done here, right? Not exactly.
Starting to save was your first hurdle; the next step is to set up a plan to gradually increase your contributions so you’re in the best position to live out your dream retirement. Sure, you could set a contribution amount in your 20s and never increase, but it’s probably unrealistic to expect that to be enough 40 years later when you’re ready to ride off into the sunset.
Over the course of your career, your income is expected to increase as you move up the ladder. As a result, if you’re contributing, say, 6% of your annual salary to a 401(k), IRA, or other retirement account, the dollar amount going to your retirement fund will increase along with your salary. That’s good news! The more you contribute to your retirement, the better chance you have to achieve your retirement goals.
However, there’s more you can do to help your retirement cause. What if you gradually increase your rate of contribution on a regular basis? The 1% rule can help. This rule of thumb involves raising your retirement contributions by 1% of your annual salary every year. The strategy rests on two pillars:
But 1% percent? What kind of impact can that make?
The answer? A big one.
To see the impact, let’s consider the following example.
Let’s say you’re 30 years old, have an annual salary of $50,000, and started contributing 5% of your salary to your 401(k) this year. Every five years, your salary grows about $10,000 (via raises, promotions, or moving to new companies).
Consider the following examples of retirement plans. The only difference between them is how often the contributions increase:
Percentage Increase |
Frequency of Increase |
Total Contributions |
Balance at 45 |
1% |
Annually |
$129,000 |
$191,309 |
5% |
Once every five years |
$111,000 |
$162,652 |
0% |
Never |
$49,000 |
$81,688 |
*Example assumes a hypothetical 7% annual rate of return, compounded annually.
As you can see, the 1% rule takes the cake. Making small increases every year yields a greater return in the example, plus it’s easier to manage those small changes to your budget.
Always keep in mind that your account has yearly contribution limits. In 2020, the annual contribution limit for a 401(k) is $19,500 (or $25,500 if you’re 50 or older); for IRAs, it’s $6,000 ($7,000 if you’re 50 or older).
If you reach the annual limit, you may have other options to continue saving, like opening another type of retirement account. So if you’re 45 and you’ve reached the $19,000 limit in your 401(k), you can open a Roth IRA to allot any further contributions (provided you are within the income limits).
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