Last week, the IRS announced that 401(k) contribution limits will increase by $500. In 2020, employees who participate in an employer-sponsored plan will be able to contribute as much as $19,500 per year, up from $19,000 in 2019.
If you're 50 or over, you can now contribute an additional $6,500 (up from $6,000), for a total of $26,000 every year.
These limits are much higher than those on IRAs (individual retirement accounts), which allow you to contribute up to $6,000 a year in 2020, or $7,000 if you're 50 or older, which is one of the many benefits of using a 401(k) plan. Another benefit is that contributions are made pre-tax, so the more you put in, the more you reduce your taxable income.
Experts typically recommend contributing at least enough to get the full 401(k) match, which is essentially "free money" from your company: If your employer offers this perk, they will typically match whatever contribution you put towards your 401(k) up to a certain amount (the average employer 401(k) match is 4.7%). Whatever your company matches does not count towards the contribution limit. If you put $19,500 into your 401(k) in 2020 and your company adds an extra $5,000, you're still within the IRS limits.
If you're getting the full match, that's a great place to start, but the more you can set aside for your future self, the better off you'll be. If you max out your 401(k) plan every year, your money could grow significantly over time.
You can start withdrawing your 401(k) funds penalty-free at age 59 ½. CNBC Make It crunched the numbers to show you just how big your 401(k) balance would be if you invested $19,500 every year starting at various ages and didn't touch the money until age 70. The numbers are based on a 6% monthly rate of return (accruing interest monthly on the monthly payment, not the annual rate).
Note that if the contribution limits continue to rise, you'll be able to save and invest more every year if you max out your account, meaning you'll end up with even more money come retirement.
- If a 25-year-old starts investing $19,500 a year, their account would grow to $4.48 million by age 70.
- If a 30-year-old starts investing $19,500 a year, their account would grow to $3.24 million by age 70.
- If a 35-year-old starts investing $19,500 a year, their account would grow to $2.32 million by age 70.
- If a 40-year-old starts investing $19,500 a year, their account would grow to $1.63 million by age 70.
- If a 45-year-old starts investing $19,500 a year, their account would grow to $1.13 million by age 70.
As the numbers show, time is on your side when you're young, thanks to the power of compound interest. The sooner you start putting your money to work, the less you'll have to save each month to reach whatever your retirement goal may be, such as $1 million.
If you want to max out your 401(k) in 2020, you'd have to save about $1,625 per month, or about $750 per paycheck if you get paid every other week (26 paychecks per year). Figure out what percentage of your paycheck that equates to and start contributing that amount.
That's a lot to save and may not be possible for everyone. If you're only comfortable with putting away 1%, it's better to start there and gradually increase your contributions than to not get started at all. A helpful tool your company may provide is "auto-increase," which allows you to choose the percentage you want to increase your contributions by and how often. That way, you can have your contributions automatically go up by a small percentage every six months, at the end of each year or every other year.
If you don't have a 401(k), there are other ways to put your money to work. Consider alternate retirement savings accounts, such as a Roth IRA, traditional IRA, SEP IRA and/or a health savings account.
You can also fund a regular brokerage account. "There's no rule that says you have to save for retirement in your retirement account," Nick Holeman, a certified financial planner at Betterment, tells CNBC Make It.
IRAs "have some nice tax benefits, so that should be where you start," he notes, "but they have some restrictions on them," such as contribution limits and when you can withdraw the money. Generally, if you dip into an IRA before 59½ you'll get hit with an early withdrawal fee. There are exceptions, the IRS site says, "such as using IRA funds to pay your medical insurance premium after a job loss."
"For someone who wants a little more flexibility or is thinking about retiring early, it might make sense to save money outside of these retirement accounts, in a normal investment account," says Holeman. "You don't get as many tax benefits, but you have a lot more flexibility: There's no age restrictions on pulling the money out and there's no contribution limit."
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