New contribution levels make 401(k) plans more attractive
If you are interested in saving for retirement, here’s some good news: For 2015, the IRS has raised the maximum contribution limits for 401(k) plans from $17,500 to $18,000. And if you’re 50 or older, you can put in an extra $6,000, up from $5,500 in 2014.
These same limits also apply to 403(b) plans, for employees of public schools and nonprofit organizations, and to 457(b) plans, for employees of state and local governments and other governmental agencies, such as park boards and water districts. So, in other words, a lot of workers have gotten a “raise” in their ability to contribute to tax-advantaged retirement plans.
Although you may not think you will ever contribute the maximum amount to your retirement plan, you may still benefit from making small increases each year. Unfortunately, many people don’t do this. In fact, approximately 30 percent of eligible workers don’t even participate in their employer’s 401(k)-type plan, according to the Employee Benefits Security Administration, an agency of the U.S. Department of Labor. And the median savings rate for these plans is just six percent of eligible income, with only 22 percent of employees contributing more than 10 percent of their pay, according to a recent report by Vanguard, an investment management company.
In any case, you do have some pretty strong motivations to put in as much as you can possibly afford. First of all, your 401(k) earnings grow on a tax-deferred basis, which means your money has more growth potential than it would if it were placed in an account on which you paid taxes every year. Eventually, though, you will be taxed on your withdrawals, but by the time you start taking out money, presumably in retirement, you might be in a lower tax bracket.
But you can also get a more immediate tax-related benefit from contributing as much as you can to your 401(k). Consider this hypothetical example. Suppose that you are in the 28 percent tax bracket. For every dollar you earn, you must pay 28 cents in taxes (excluding state and other taxes), leaving you 72 cents to spend as you choose. But if you put that same dollar into your 401(k), which is typically funded with pre-tax dollars, you will reduce your taxable income by one dollar — which means that if you did contribute the full $18,000, you’d save $5,040 in federal income taxes. Your particular tax situation will likely be impacted by other factors, but you’d have that $18,000 working for you in whatever investments you have chosen within your 401(k) plan. If you kept contributing the maximum each year, you will be giving yourself more potential for a sizable fund for your retirement years.
Even if you couldn’t afford to “max out” on your 401(k), you should, at the very least, contribute enough to earn your employer’s match, if one is offered. (A common match is 50 cents per dollar, up to six percent of your pay.) Your Human Resources department can tell you how much you need to contribute to get the greatest match, so if you haven’t had that conversation yet, don’t put it off.
As we’ve seen, investing in your 401(k) is a good retirement strategy — you get tax benefits and the chance to build retirement savings. And with the contribution limit increasing, you’ve got the chance for more savings in the future.
Doug Drost is a certified financial planner for Edward Jones, 2262 Reno Highway.