February 1, 2010
The first thing you do when signing up for your employer's 401(k) or 403(b) is decide how much to put in out of every paycheck. You don't need my advice for that, of course; it's a function of how much you can afford. But once you decide on the amount, on how much you're willing to save toward your future, that's where this bit of advice comes in.
You already know there is a tax savings from contributing to your plan. Here's how that works: every dollar you contribute is subtracted from your pay before Federal & State withholding taxes are calculated. Since your contribution escapes income tax, the amount of tax withheld from your pay is less, thus your net pay rises a bit. Put another way, for every dollar you put in your plan, your take-home pay will only drop by 75 or 80 cents. It really means that you're putting money in your plan that otherwise would have gone to taxes, but it also means that you need to do a little simple math to grow your savings faster than the average person.
To keep the math at its simplest do this: settle on how much you can afford to contribute and divide it by .8 to arrive at a slightly larger amount, which is what you should contribute. If you decide that $25 is what you can afford, dividing that by .8 gives you $31.25. The effect is to allow you to contribute the $31.25 but see your net pay reduced by only about $25. The extra six bucks is what would otherwise go for taxes - you are legally keeping the Fed & State share and investing it! That's money in your pocket.
The numbers in this example are approximate, always consult your advisor or sharpen your pencil to get a result specific to your circumstances.
Tomorrow: Ground Rule #2: Percents, Not Dollars!
(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).