There is no time like the present to increase your retirement plan contributions, but those who commit more of their hard-earned salary to their retirement nest egg must be mindful of the IRS limit.
Indeed, the federal government places limits on the dollar amount individuals may contribute to tax-favored accounts each year, including individual retirement accounts and 401(k)s, which adjust annually to reflect cost-of-living increases.
The retirement plan contribution limit for 401(k), 457(b) and 403(b) plans is $19,000 for tax year 2019 ($19,500 for 2020.) If you are age 50 or older by the end of the calendar year, you may be eligible to make additional catch-up contributions of up to $6,000, bringing the total you may contribute on a pre-tax basis for 2019 to $25,000. For tax year 2020, the contribution limits will increase to $19,500 and the catch-up contribution limit increases to $6,500.1
The maximum yearly contribution to traditional and Roth IRAs is $6,000 for 2019, which will remain unchanged in 2020. Those 50 and older can make an additional catch-up contribution of up to $1,000 to their traditional or Roth IRA, as well. In the case of a Roth, you may not be eligible to contribute that much, however, depending on your income or your filing status.2
An additional preretirement “catch-up” provision exists for state and local government employees, and some nonprofit workers who are eligible for a 457(b) plan, but the plan has to specifically allow the catch-up contribution in its terms. The special 457(b) preretirement catch-up is available during the three years prior to, but not including, the year in which plan participants will reach normal retirement age. Those who qualify can contribute either twice the annual limit ($38,000 in 2019 and $39,000 for 2020) or the basic annual limit plus the amount of the basic limit not used in prior years — whichever is less. That option is only available, however, if the plan participant is not already taking advantage of the standard age 50 and older catch-up contribution; it is one or the other, not both.3
Thus, if your normal retirement age is 65, you would only be able to make 457(b) preretirement catch up contributions during the years in which you were 64, 63, and 62. But in the years between ages 50 and 61, you have the option to take advantage of making the 50-years-or-older catch-up contributions.
If you do not plan to make 457(b) preretirement catch up contributions, you can instead make 50-years-or-older catch-up contributions from age 50 until the year you retire.
There have been recent changes by Congress that have eliminated age limits for IRA contributions. Additionally, ages for required minimum distributions (RMDs) were also pushed back. (Related: SECURE Act changes to retirement rules)
Separately, the CARES Act, which provided relief for families experiencing financial hardship during the coronavirus pandemic, also waived RMDs for 2020. That enabled taxpayers who are age 70-1/2 or older to skip their 2020 distribution from their pretax retirement portfolios if they chose to do so. The 2020 waiver applies to 401(k), IRA, SEP IRA, SIMPLE IRA, 403(b), and governmental 457(b) plans. It also applies to beneficiaries taking stretch distributions. (Learn more: What the stimulus package means for you)
Some taxpayers, of course, had already taken their 2020 RMD before the waiver went into effect on March 27. Many wanted to return the distribution to their account, but were initially unable to do so as a non-taxable rollover. On June 23, 2020, the IRS announced that anyone who already took an RMD in 2020 can now roll those funds back into their IRA until August 31, 2020.
Even a minor increase to your retirement account contribution can yield big returns for your long-term financial security.
A 30-year-old woman making $60,000 a year with nothing yet saved for retirement would accumulate $917,749 by age 65 if she contributed 5 percent of her salary to her retirement plan. That assumes a 3 percent raise per year, a hypothetical 7 percent annual investment return, and 50 percent employer match, up to 6 percent of her salary, according to the AARP 401(k) calculator.
If she instead contributed 10 percent of her salary each year with the same assumptions, her retirement savings account would total $1,591,000.
“Most people are going to fall well short of their savings goal, so you should always save as much as you can, but at least enough to get the employer match,” said Matt Rutledge, a research economist at the Center for Retirement Research at Boston College. “You don’t want to leave money on the table.”
Many financial professionals recommend retirement savers sock away between 10 percent and 15 percent of their income annually. But that is merely a guideline.
It all depends on the age you start saving, said Rutledge.
“If you start saving early, at around age 20, you can afford to save 10 percent of your salary, but if you wait until age 30 to start saving, you will need to increase your contribution to 15 percent or more because you will have lost some of the power of compounded growth,” he said. “The earlier you start saving, the easier it is to hit your goals.”
Those percentage targets include the employer match, “so it may be a little easier than you think” to save a sufficient amount, said Rutledge.
To estimate how much money you will need to retire comfortably, project your future expenses and calculate your guaranteed sources of income from Social Security, annuities, and any pensions you may have. (Calculator: How much should I save for my retirement?)
The difference is what you will need to generate from personal savings and investments to fund your monthly living expenses.
A 4 percent withdrawal rate from your nest egg, adjusted annually for inflation, is generally considered to be a safe target to ensure that you don’t outlive your retirement savings.
But once again, retirement planning is not one size fits all. You may be able to withdraw more (or less) depending on the amount you have saved, your life expectancy, the return on your investments, and your monthly living expenses.
You may also be able to mitigate the risk of outliving your retirement accounts by purchasing a deferred income annuity, which can act as longevity insurance, said Rutledge.
Such products provide guaranteed income for life starting at a specified point in the future.
Deferred income annuities “make a lot of sense for a lot of people, because you don’t have to worry so much about whether a 4 percent withdrawal rate is right,” said Rutledge. “You can spend your savings a little more freely, because you know that you only need to make your money last until the (annuity) kicks in.”
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This article was originally published in October 2016. It has been updated.
1 Internal Revenue Service, “401(k) contribution limit increases to $19,500 for 2020; IRA limit increases to $6,500,” November 6, 2019.
2 Internal Revenue Service, “Retirement Topics — IRA Contribution Limits,” December 4, 2019.
3 Internal Revenue Service, “Retirement Topics — 457(b) Contribution Limits” November 12, 2019.