Though there are several vehicles out there to help you save for retirement, one of the most effective is none other than the 401(k). The appeal of the 401(k) is twofold. For one thing, contributions are seamless. You sign up through your employer, decide what percentage of your paycheck to set aside, and sit back as that money is automatically deducted tax-free each month. But the other factor that makes 401(k)s so appealing is their generous annual contribution limit. Whereas IRAs cap out at $5,500 a year for workers under 50, the current annual contribution limit for 401(k)s is $18,000.
And here's some good news for those who tend to max out their 401(k)s: Come 2018, you'll have the option to contribute an additional $500 for a total of $18,500.
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Now that $500 boost may not seem like much, but from a tax perspective, it's a welcome change. That's because if you max out your 401(k) in 2018, and your effective tax rate is 30%, you'll shave $150 off your IRS bill -- just like that. (Note that because those 50 and over get a $6,000 catch-up, older workers can contribute up to $24,500 next year.)
But while an increased 401(k) contribution limit may be reason for some folks to celebrate, those who plan to capitalize on that allowance are undoubtedly in the minority. In fact, most workers will find the new contribution limit virtually meaningless, since the typical American doesn't come close to maxing out his or her 401(k) in the first place.
Passing up a key savings opportunity
Before we talk about what the average American contributes to a 401(k), let's remember that not all workers have the option to participate in one. It's estimated that 79% of the workforce has access to a 401(k), which puts 21% of workers at an automatic disadvantage. But despite the fact that most employed adults are offered a 401(k), only 41% opt in.
Furthermore, of those who do participate, the overwhelming majority don't come close to hitting the annual limit. Vanguard reports that the average worker saved 6.8% of his or her income in a 401(k) in 2015. Since the average income in the country for folks under 65 is $46,409, those earning that much but setting aside just 6.8% of their income are contributing a mere $3,155 per year.
In fact, Vanguard says that only 12% of 401(k) plan participants contribute the maximum amount allowed by IRS guidelines. That means the typical American who has a 401(k) won't be impacted by the option to set aside an extra $500 in 2018. On the other hand, those who are currently maxing out, and are planning to take advantage of that additional $500 contribution, stand to benefit in a very big way.
A chance to grow your wealth
At first glance, a $500 increase to your 401(k) may not seem like much. But in reality, that boost can be huge, especially if you're a younger worker with several decades of employment ahead of you.
Remember, when you increase your 401(k) contributions by $500 a year, you're not just adding that money alone to your account; you're also investing that money over a potentially lengthy period of time. And if you have several decades for compounding to work its magic, you'll pad your nest egg quite nicely by maxing out.
The following table shows what an extra $500 per year will do for your 401(k), depending on your current age:
Even if you're already a good 15 years into your career, if you contribute that extra $500 a year for another three decades, you'll get a cool $56,000 nest egg boost if your investments generate an average annual 8% return during that time. And that's more than doable with a stock-heavy portfolio.
But here's the other thing the above table is meant to illustrate: Even if you're among the majority of Americans who don't max out their 401(k)s, upping your annual contributions by $500 could have a huge impact on your ultimate savings balance. So while you may not manage to set aside $18,500 next year, do your part to save as much as you can. You'll be thankful for it in the long run.
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