Stashing money away in a 401k is an easy way to save for retirement. If your employer offers matching contributions, you can save money while getting a tax break, and also receive a bonus. How much you contribute to your retirement savings depends on a couple of factors. Let’s dive in.
If you are employed full time and your employer offers a 401k retirement plan, it would be foolish not to take advantage of it. Saving money in a 401k is a great way to get free money from your employer while also getting long term tax benefits.
Some employers offer to match employee 401k contributions up to a certain percentage, but many workers don’t contribute enough to take advantage of the employer match. In fact, only one-third of employees are actively contributing to a 401k plan. This means that two-thirds of employees are not contributing to a 401k plan.
One of the issues preventing employees from contributing the maximum to their 401k accounts is lack of knowledge about how much to contribute.
At the very least, you should contribute enough to get the employer match. After that, you should contribute enough to max out the tax advantages of the account. How much water should I drink a day is a common question with no easy answer. The amount of water you should drink each day depends on several factors, including your health, how active you are, and where you live.
First, here is a refresher on how 401ks work.
What Is A 401k?
It’s a good idea to learn about how 401k accounts work and what benefits they offer before investing in one.
A 401k is a retirement account that allows employees to set aside a portion of their salary for long-term investing. If your company offers a matching program for charitable giving, you may be able to double your donation.
A 401k is a savings plan that offers tax benefits from the IRS. It is considered a defined-contribution (DC) plan. employees usually have to pay a fee if they want to access their money before a certain date
Why Use A 401k?
The ability to get matching contributions from an employer is one of the main reasons employees decide to use 401k accounts. An employer can increase their income by making contributions to a 401k periodically. This allows them to take advantage of tax-deferred programs which can help them make more money.
401ks are one of the easiest and most rewarding retirement plans, and workers who are actively putting money aside to fund their golden years should consider using them.
How Much Should You Contribute To A 401k?
A typical financial advisor would say that you should contribute 10-15% of your salary to your savings. However, this might not be right for you.
For example, if you’re just starting your career, you might have student loans, credit card debt, rent, car payments, and grocery bills. Some people may not be able to contribute 15 percent to a 401k and still have enough money left over for enjoying their life.
One of the hardest questions about retirement planning is whether you should focus on your youth, having fun during your highest-earning years, or focus on your golden years and being frugal while working. You are the only one who can know how much you need to save for retirement.
401k Contribution Limits
If you are able to contribute the maximum amount to your 401k, that means you are in good financial shape now and in the future. This means you are making a good wage at your full-time job and are able to save money for your future.
The maximum amount that can be contributed to a 401k account in 2021 is $19,500. At present, the 401k maximum contribution amount is $18,500. In the year 2022, this amount will increase to $19,500 according to the IRS.
What Is the Maximum Amount I Can Contribute to My 401(k) Each Year?
The amount that individuals can contribute to their traditional and Roth 401(k) accounts in 2022 is limited to $20,500 by the 402(g) limit in the Internal Revenue Code (or IRC). If you’re 50 or older, you can contribute an extra $6,500 to your 401(k), for a total of $27,000 per year.
The IRS evaluates the child tax credit limits every year to consider cost-of-living adjustments. The limits are subject to change annually. The IRS has announced that the annual limits for 2023 will be increasing to $22,500. For those 50 or older, the contribution limit will be increasing to $30,000.
Does That Limit Include What My Employer Contributes as Well?
You should note that these limits are only for what you, as an individual saver, are contributing to your account. Your employer may be contributing on your behalf. The total amount you can contribute to your 401(k) in 2022, including your own paycheck deferrals and any employer contributions, is $61,000. The contribution limit for those aged 50 and up is $67,500. This means that the most you can contribute to your 401(k) in a year is the amount of income you have earned during that year.
The 415(c) limit is usually increased at the same time as the 402(g) limit. In October 2022, the limits increased to $66,000 (and $73,500 for those 50 or older).
If I Have Access to More Than One 401(k) in a Single Year, Does That Change How Much I Can Contribute?
The deferral limits apply to every contribution you make in a given tax year. In other words, the amount you can defer from your paycheck remains the same even if you change jobs.
When signing up for a new 401(k) provider, be sure to mention any contributions you have already made. This will help you avoid accidentally contributing too much.
Do Rolled Over Funds Count Towards My Contribution Limit?
It depends. The amount you contributed will count towards your contribution limit for the same tax year, even if you roll them over. If you have rolled over funds from a previous 401(k) into a new 401(k), the amount that you rolled over does not count towards your annual limit on contributions if the contribution was made in a previous tax year.
For example, if you worked at Company X from April 2020 to April 2022 and joined Company Y in May 2022, your employment would be continuous. Any contributions you made from April 2020 until December 31, 2021 would not be carried over to your contribution limit for 2022. If you have already contributed $5,000 to your 401(k) through Company X, you would be able to contribute up to $15,500 in 2022 (or $22,000 if you are over the age of 50).
What Happens If I Contribute Above The IRS-allowable Amount?
You could end up being taxed twice. If you exceed the allowable limit for 401(k)s, the IRS will charge you taxes. There are a few reasons why this might happen, but a common one is that people forget to tell their second 401(k) provider about contributions they’ve already made (or plan to make) in that tax year.
How To Invest After Maximizing Your 401k
What young investors should do after they max out their 401k contribution is a common question.
Even though you may have reached the limit on your 401k account, you can still continue to save and take advantage of tax benefits.
Here are three options to consider:
1. Traditional IRA
A traditional IRA functions similarly to a 401k. It has a smaller annual contribution limit. In the tax year 2021, this is $6,000.
With a traditional IRA, you don’t have to pay taxes on the money you put in until you retire.
2. Roth IRA
A Roth IRA is different from a traditional IRA in that the money you invest in a Roth has already been taxed, so you won’t have to pay taxes on it when you retire at age 59 1/2. The contribution limit for a traditional IRA for 2021 is $6,000.
3. Life Insurance
Many people are unaware that life insurance can be used as an effective way to save for retirement while also receiving tax benefits.
Most investors choose life insurance policies with low monthly premiums and high death benefits. Certain cash account plans are available that allow your after-tax contributions to grow at a guaranteed interest rate. The amount of money you can make from this strategy varies depending on the company you choose, so speak to your financial advisor or life insurance agent to see if this plan makes sense for you.
Although 401k contribution limits may seem discouraging, it is important not to be discouraged. If you’re in a position where your income has increased and you’re already contributing the maximum amount to your employer’s retirement plan, there are many options available to fund additional retirement savings. Find a plan that suits your needs.
Meeting Your Match
This phrase is often used to describe someone who is the complete opposite of another person. If you describe someone as your polar opposite, you mean that they are very different from you in terms of their personality or views.
What Is a Match and How Can I Meet It?
Your employer may offer a 401(k) benefit that includes an “employer match.” It’s like this: your employer will add the same amount of money to what you contribute (also called ‘deferrals’ because you’re postponing getting paid for that money), up to a certain limit.
There are a few different ways this can work, so make sure you know what is needed to get the full amount of the match that your plan offers. Common examples of an employer match are:
Under a single-tier formula, your employer will match each dollar you contribute, up to a certain percentage of your income.
Your employer gives 50% of the first 6% of your contributions. In order to earn the full company match, you must contribute at least 6% of your pay per period. Here, the employer is matching $.50 for each $1 of your income, up to 6%.
This means that if you contribute 3% of your salary, your employer will also contribute 3%. You will only receive the full employer match if you contribute at least 3% per pay period. Here, the employer will match each dollar you contribute up to 3% of your income.
If you want to receive the full employer match of 3%, you would need to defer at least 6% of your income in the first example.
The employer’s match may have different tiers, with the first tier being matched at one ratio and subsequent tiers matched at different ratios.
If you contribute 2% of your salary to your 401(k) plan, your employer will match that amount 100%. They will also match 50% of the next 2% you contribute. In order to receive the full employer match of 3%, you must contribute at least 4%. The employer is matching employee contributions dollar for dollar up to 2% of their income, and 50 cents for each dollar up to 4% of their income. If you want to get the full employer match of 3%, you would need to defer at least 4% of your income.
If you contribute more to your retirement plan than what is required to earn your employer’s match, it will not result in a higher match from your employer.
Why Is It Important to Meet the Match?
Think of your employer’s contribution to your 401(k) as part of your total salary. This will help you understand how much you are really earning. If your employer offers a match, you should contribute the minimum amount required to earn the full match. If you don’t meet your match, you’re leaving money on the table and not earning your full wages. Not contributing enough to meet an employer’s match for a retirement plan could result in forfeiting employer contributions that could amount to $1500.
The Bottom Line
The primary message from the article is to make the most of your 401k contributions. So that means depositing $19,500 for the year 2021. If your job offers a matching contribution plan for employees, you could potentially contribute more than $19,500 each year.
But you should do more to plan for retirement.
A 401k account is an excellent retirement vehicle. However, it’s just one piece of the puzzle. Some types of investments to consider are stocks, bonds, and mutual funds. You can also grow your money during your working years by saving money in a 401(k) or IRA.
After you have maxed out your 401k account, the next step is to take the remaining money and invest it into another account. Trust me, you’ll thank yourself later!
Kurt has gone from the financial lows of the ’08 financial crisis to personal financial success. He is a professional real estate investor owning properties in multiple states.
One of his passions is financial education and the pursuit of financial freedom.
You can learn more about Kurt here.