There's good news on the horizon for the 80% of workers who expect their 401(k) accounts to serve as their most important source of retirement income. Contribution limits for 401(k) accounts are rising in 2018, so you can sock away more tax-free cash for your retirement.
Whether you're currently maxing out your 401(k) contributions or are looking for ways to save more in the New Year, you can find out everything you need to know right here about the new rules for 401(k) investments in 2018.
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What are the maximum 401(k) contribution limits for 2018?
The maximum contribution limit for 401(k) accounts in 2018 is rising to $18,500 for elective contributions, up from $18,000 in 2017. Elective contributions are money you choose to have withheld from your paycheck and invested for retirement.
For older workers 50 and up, additional catch-up contributions are permitted. Catch up contributions are additional elective contributions older workers can make on top of the $18,500 every eligible worker can invest. In 2017, older workers were allowed to make catch-up contributions of $6,000. This amount did not increase in 2018, so workers 60 and over will be allowed to contribute a maximum of $24,500 in elective contributions in 2018, compared with $24,000 in 2017.
Matching contributions from employers, non-elective contributions, and allocations of forfeitures are not counted in the $18,500 or in the $24,500 maximum elective contributions. However, there is a total limit for all contributions from all sources. This limit is also rising $1,000 in 2018 compared with 2017. The new maximum contribution from all sources will be $55,000 for workers under 50, and $61,000 for workers 50 and over.
How much additional tax savings will you realize?
Investing with pre-tax funds provides substantial savings for taxpayers. The extent of your tax savings depends on your tax bracket. For taxpayers previously maxing out their 401(k) accounts who can now contribute an additional $500 in pre-tax funds, this chart shows the additional tax savings based on individual tax brackets.
You do not need to itemize your deductions to get tax breaks for 401(k) contributions. When you make contributions to your 401(k), your elective contributions are deducted directly from your paycheck. When your employer sends a W-2 at the end of the year declaring your wages, 401(k) contributions deducted from your paycheck will not be included as taxable income.
However, it's important to remember that while you won't be taxed on money invested in your 401(k), you'll be taxed on withdrawals as a senior.
How much is an extra $500 in 401(k) contributions worth?
Increasing contributions by $500 may not seem like it will make much of a difference, but compound interest works its magic on the money invested in your 401(k). If you increase your 401(k) contributions by the extra $500 you're allowed to contribute in 2018 and you earn 7% on invested funds, consider how much this $500 could turn into by the time you turn 65, depending upon your age in 2018.
With the median retirement account balance for households between ages 50 and 55 at just $8,000, individuals who start maxing out their 401(k) early on could make more just from this extra $500 investment made in 2018 than the total savings of a substantial number of pre-retirees.
What if you don't hit the 2018 401(k) contribution limits?
The average American with a 401(k) contributes about 6.2% of their income, according to Vanguard's 2017 How America Saves report, which means you're not alone if you're not contributing the maximum permitted.
But the more you can contribute, the more secure your retirement will be. To painlessly increase contributions, immediately divert any raises toward extra 401(k) contributions so you don't get used to living on the extra income.
Emulating the habits of retirement super savers who contribute at least 90% of the annual 401(k) contribution limit could also help you boost contributions dramatically. These habits include driving an older vehicle, living in a modest home, skipping out on fancy vacations, and putting in extra hours on the job.
If you're not ready to go that far but you're living in one of the 60% of households without a budget, consider creating one so you can find wasted money to redirect to 401(k) contributions.
What if you do hit the 2018 401(k) contribution limits?
If you're already maxing out your 401(k), you can invest in other tax-advantaged retirement accounts, including a traditional or a Roth IRA, which have combined contribution limits of $5,500 for most workers in 2018. There's also an additional $1,000 catch-up contribution for workers 50 and over for IRA accounts, so older employees who max out IRAs could save up to $6,500.
Traditional IRAs allow you to invest with pre-tax funds, while Roth IRAs are investments made with after-tax dollars that allow you to withdraw money tax-free as a senior. There are income limits to take advantage of the tax benefits of both traditional and Roth IRAs. Here they are for 2018.
Making your 401(k) contributions count
Whether you're maxing out a 401(k) or are just starting to step up your contributions, make sure the money you're investing is working for you. This means making sure your portfolio has the right risk allocation, that you aren't paying high fees, and that you aren't making mistakes like borrowing from your 401(k).
By investing as much as you can up to the 2018 401(k) contribution limits and making smart investment choices, your 401(k) will hopefully become the primary source of retirement income that you're likely hoping it will be.
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