401k Contribution Limits: Higher Than You May Think
Do you know what the 401(k) contribution limits are for 2015? Most employees simply contribute enough to their 401(k) in order to take full advantage of their employer's matching contributions, but the reality is that you can likely contribute much more than that. Increasing your 401(k) contributions can dramatically boost your retirement nest egg, as well as lower your tax bill this year. So, how much can you contribute? The answer might surprise you.
Employee contribution limits
For 2015, the 401(k) contribution limits for elective deferrals are $18,000, or $24,000 if you're over 50 years old. Bear in mind that "elective contributions" refers only to the money you choose to contribute. This limit doesn't include any mandatory contributions, or any contributions your employer makes on your behalf.
It's also worth mentioning that the 401(k) contribution limits apply to the total amount contributed to all employer-sponsored retirement plans. For example, if you're under 50 years old and have two jobs that both have 401(k) plans, the most you can choose to defer into both plans combined is $18,000.
The overall 401(k) contribution limits for 2015 include all contributions -- elective deferrals, non-elective (mandatory) contributions you make, and any employer contributions. And the limit is rather generous at $53,000, or $59,000 for individuals over age 50 for the 2015 tax year.
Higher contributions can lower your tax bill
It's important to realize that 401(k) contributions that are taken out of your paycheck are made on a pre-tax basis, meaning that they reduce your taxable income.
For example, if you earn $80,000 in 2015, but choose to contribute $5,000 to your 401(k), your taxable income will be reduced to $75,000 -- before any other tax deductions or credits are applied. Boosting your contributions to $10,000 will further reduce your taxable income to $70,000. The effect is pretty nice -- not only will you build up a bigger retirement nest egg, but boosting your retirement savings by $5,000 could also mean a 2015 tax bill that's $1,250 lower (assuming you end up in the 25% tax bracket after your other deductions and credits).
Another potential tax benefit, but one that requires a little more homework, is the ability to qualify for certain tax credits and deductions that depend on your income being below a certain level. For example, if you are a married couple filing jointly, you are eligible to get a credit of up to $2,500 for paying your kids' college tuition if your modified adjusted gross income is below $180,000. So if you're on track to produce an adjusted gross income of, say, $185,000 this year, and would otherwise qualify for the credit, it might be a savvy financial move to increase your 401(k) contributions in order to get below the threshold.
You don't need to max out, but every little bit helps
Now, I completely understand that most people reading this don't have the need (or ability) to completely max out their 401(k) contributions. However, the point here is to get you thinking about how much you can reasonably afford to save for retirement, and the difference a little more can make.
As a simplified example, consider a 35-year-old employee earning $80,000 per year whose employer is willing to match a 401(k) contribution up to 5% of his or her total salary. If the employee contributes 5% of his or her salary, this could result in a $928,000 nest egg in 30 years, assuming a historically conservative 7% average rate of return. Not bad, right?
While this is certainly a lot of money, the commonly used "4% rule" of retirement says that you should be able to comfortably withdraw just over $37,000 per year from your account each year after retirement. If this doesn't sound like enough to live on, check out the difference that an increase of just a few percent can make.
Employee Contribution (% of salary)
Employer Contribution (% of salary)
Potential account value after 30 years
Note: Assumes 7% average investment returns and 2% annual salary increases.
While most of us will never come close to the 401(k) contribution limits, the point here is that there is a lot of room to increase your contributions. Doing so can not only mean hundreds of thousands of dollars in additional retirement savings, but it can also help cut your tax bill for this year. It may seem like a lot to commit the extra money now, but your future self will certainly be grateful.
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The article 401k Contribution Limits: Higher Than You May Think originally appeared on Fool.com.
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