The 2015 401(k) Limits -- How They Can Make Your Dream Retirement a Reality

By Markets Fool.com

Continue Reading Below

Source: www.taxcredits.net via Flickr.

Most employees with a 401(k) plan contribute enough to take full advantage of their employer's matching contributions. However, you may be surprised to learn that this could just be the starting point for your retirement savings. Despite what many people believe, the 401(k) limits are rather generous, and even a small increase in contributions could make a big difference in your retirement.

How much can you contribute to your retirement?
For the 2015 tax year, you're allowed elective deferrals of $18,000 into your 401(k) account, and an additional $6,000 if you're over 50. Bear in mind that this includes only money that you voluntarily contribute.

This amount is in addition to any contributions your employer makes into your account, or any mandatory contributions you're forced to make as a condition of employment. Because some employers have rather generous matching programs, particularly for veteran employees, the IRS has an overall cap of $53,000 for all contributions ($59,000 if over 50).

This is also in addition to any money you decide to contribute to an IRA. For the 2015 tax year, you can contribute up to $5,500 ($6,500 if over 50) to an IRA, and you may be eligible for a tax deduction on your traditional IRA contributions.

Continue Reading Below

Are your current contributions enough?
If you're contributing enough to take full advantage of your employer's matching program, that's a good start. However, you should look at this as a starting point, as it may not be enough to provide for your retirement needs.

As a rule of thumb, to maintain your quality of life, plan on requiring about 80% of your pre-retirement income after you retire. Of course, everyone's expenses are different, and there are plenty of ways to cut costs, but this is a good estimation for most people.

So take your expected salary at the time of your retirement (it's OK to estimate), and multiply it by 0.8. Then, estimate how much annual income you can expect from Social Security, and subtract if from the total. That's how much income you'll need from your retirement savings.

As another rule of thumb, you can expect to safely withdraw about 4% of your savings every year to make sure your money last as long as you do. (Note: Just like the "80% rule," this isn't perfect, but it is a good way to get an idea of where you stand.)

Finally, take your income requirement and multiply it by 25. That's how much you should aim to have saved by the time you retire. Most companies' plans will include a "retirement forecast" of some kind on your statements to let you know where you're on pace to end up, so it's definitely worth checking yours to see if you're on track for a shortfall.

A little can go a long way
Let's look at an example of a 35-year-old worker who plans on retiring at 65. We'll say that this person earns $50,000 per year now and already has a 401(k) balance of $45,000. This person's employer is also willing to match up to 4% of salary, dollar for dollar.

Based on average annual returns of 7% and 2% annual salary increases, this should produce a retirement nest egg of about $784,000 by age 65. Although that sounds like a lot (and it is), bear in mind that when you account for inflation, as well as the fact that you should expect to withdraw only 4% of this amount each year, it could fall short of what you need. However, by simply increasing the employee's contribution by a small amount, look at what a difference it could make over the long run.

Employee Contributions (% of Salary) Employer Match Potential Value in 30 Years
4% 4% $784,213
5% 4% $842,222
6% 4% $900,231
7% 4% $958,240
8% 4% $1,016,249
9% 4% $1,074,258
10% 4% $1,132,267

Assumes 2% annual salary increases and 7% average investment returns.

You don't need to max out, but every little bit helps
Although it's not necessary (or practical) for everybody to contribute the maximum allowable amount to a 401(k) plan, it's still a good idea to contribute what you can. Here are a couple of strategies that could help you painlessly boost your retirement savings rate

  • Try increasing your elective contributions by 1% of your salary per year until you reach a target percentage. For example, let's say you currently contribute 4% of your salary because that's what your employer is willing to match. Under this strategy, you could increase your contributions to 5% in 2016, 6% in 2017, and so on until you hit your target -- say, 10%. This way you won't feel the financial strain all at once, and you'll be a 401(k) high achiever before you know it.
  • Another good strategy is to "split the difference" in salary whenever you get a raise. For example, if you get a 4% raise, you could increase your retirement contributions by 2% of your salary. Your paychecks will still go up, and you'll give your future self a "raise" at the same time.

No matter how you do it, it's a good idea to take a look at your 401(k) progress and make adjustments accordingly. As we've seen here, it may take only a small boost to create the retirement nest egg you want.

The article The 2015 401(k) Limits -- How They Can Make Your Dream Retirement a Reality originally appeared on Fool.com.

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.