The 401(k) plan is the most common type of retirement savings plan U.S. employers use, and the IRS can annually adjust contribution limits. For 2017, your contribution limit (aka "elective deferral limit") remains the same at $18,000 while the overall 401(k) contribution limit has changed slightly. Here are the details of 401(k) contribution limits, some alternative types of accounts, and some strategies to help you maximize your retirement savings.
Continue Reading Below
2017 is a great time to get your 401(k) contributions in order. Image Source: Getty Images.
The 2017 401(k) contribution limits
For the 2017 tax year, 401(k) participants can choose to have up to $18,000 of their compensation placedinto their account, with an additional $6,000 catch-up contribution allowed for participants 50 and older. These limits haven't changed for the past two years.
However, the overall 401(k) contribution limits have increased for 2017. Including your elective deferrals, as well as any employer matching contributions, nonelective employee contributions, and any allocations of forfeitures, the overall 401(k) contribution limit is $54,000. For participants 50 or older, the $6,000 catch-up allowance applies to this limit as well, translating to an overall limit of $60,000. You also can't contribute more than your total compensation.
Data source: IRS.
403(b) and 457(b) limits
It's also important to mention that these limits apply to certain other types of retirement plans as well, such as 403(b) plans, which public schools and certain charities offer.
403(b) plans have an additional provision for catch-up contributions. If the plan allows, eligible employees with at least 15 years of service can potentially add up to $3,000 in additional elective deferrals each year, even if they're not 50 years old yet. Once they reach age 50, the previously mentioned catch-up contribution limit applies, and an employee can use both catch-up provisions simultaneously, if applicable.
457(b) plans are another example of a retirement plan that's subject to the same elective deferral limits. Certain state and local governments and other tax-exempt entities offer these retirement plans. 457(b) plans may have a special catch-up provision that allows participants within three years of the plan's normal retirement age to contribute up to twice the annual limit, or $36,000.
If you're self-employed, you can choose to participate in your own 401(k) plan, often referred to as a solo or individual 401(k). In this situation, you are considered both the employer and employee for contribution purposes.
On the employee side, the same elective deferral limit of $18,000 applies, and you can defer up to $24,000 if you're 50 or over. In addition, your employer contribution can be up to 25% of your compensation, which you can figure out using these IRS guidelines. Regardless of how much self-employment income you earn, the overall limit of $54,000 ($60,000 if 50 or over) still applies to your Individual 401(k).
In addition to an Individual 401(k), self-employed individuals have the option to save for retirement in other special account types, such as a SIMPLE IRA or SEP-IRA. Each of these accounts has its own contribution limit and rules, so check out the links for a full description of each. Of course, self-employed individuals can also take advantage of traditional and Roth IRAs.
2017 IRA contribution limits and benefits
Traditional and Roth IRAs are the other widely available type of retirement savings account. Both accounts allow for contributions of $5,500 for the 2017 tax year, with an additional $1,000 contribution allowed for savers 50 and older.
The major difference between traditional and Roth IRAs is the tax treatment. Traditional IRAs work like most 401(k) plans. Contributions may be tax-deductible depending on your income, but your eventual withdrawals will be treated as taxable income. On the other hand, Roth contributions are made on an after-tax basis. That is, you won't get a current-year tax deduction, but qualified withdrawals will be 100% tax-free. Because of the after-tax nature of Roth contributions, these accounts have several other benefits, which you can read about here. Just to name a few:
- Because you've already paid taxes on them, Roth contributions (but not any investment gains) can be withdrawn without penalty at any time.
- Roth IRAs have no required minimum distributions, unlike 401(k) and traditional IRA accounts.
- You can contribute to a Roth, regardless of your age, if you still earn income (note that there are income limits, though).
Both types of IRA accounts allow your investments to grow and compound on a tax-deferred basis, meaning you won't have to worry about paying taxes on capital gains and dividends each year. While the contribution limits are significantly lower than those of 401(k)s, IRAs can be a good addition to your retirement strategy for a few reasons.
- IRAs allow you to invest in any stock, bond, or mutual fund you choose, while your 401(k) limits you to a relatively small selection of investments.
- Because you have so many choices, you may be able to find comparable investment funds to your 401(k)'s offerings, but with lower fees.
- Roth IRAs can allow you to lock in your current tax rate and won't tie up your contributions until retirement.
If your employer offers a matching contribution program, it's almost always a good idea to contribute enough to take full advantage of it. However, if you want more freedom with your investments, an IRA can be a good choice for any additional retirement savings.
Tax benefits of 401(k)s and other retirement accounts
I already mentioned the tax-deductible nature of 401(k) and other pre-tax retirement contributions. This is an extremely valuable benefit, as it allows more of your money to be put to work for your future, and it lowers your tax liability. For example, if you contribute $10,000 to your 401(k) in 2017 and you fall into the 25% tax bracket, you'll save $2,500 on your 2017 tax bill, compared with what you would have paid had you not contributed at all.
In addition, low- to moderate-income employees can take advantage of the retirement savings contributions credit, also known as the "saver's credit," which can literally give you free money to save for retirement.
Depending on your income, this credit can be worth 10%, 20%, or even 50% of your first $2,000 in retirement contributions each year. Married couples can take the credit for each spouse -- for up to $4,000 in contributions altogether.
For the 2017 tax year, here's a table that can help you determine your eligibility for the saver's credit, and how much it could put back in your pocket.
Data source: IRS.
Tips to maximize your 401(k)
The obvious way to maximize your 401(k) is to contribute as much as possible, but it's not practical for many of us to contribute as much as we're legally allowed. However, you may be surprised at how much of an impact a small increase can make over time. If you'd like to contribute more to your 401(k) but don't think you can afford to contribute as much as you'd like right away, increasing your contributions gradually could be the way to go.
One popular strategy is to increase your contribution rate by 1% of your salary each year until you reach your desired savings rate. For example, if you'd like to defer 10% of your salary into your 401(k) and currently contribute 5%, try increasing your rate to 6% in 2017, 7% in 2018, and so on, until you reach your desired savings rate of 10%.
Another option is to increase your contribution rate whenever you get a raise. For example, if you get a 3% raise this year and increase your savings rate by 1%, your paychecks will still increase, and your retirement savings will grow faster.
Finally, another smart 401(k) move that doesn't take too much effort is to examine the fees you're paying on your 401(k) investments and see if there may be cheaper alternatives that will achieve the same objectives. You can find your fees listed as the expense ratio in your 401(k)'s literature, and generally speaking, lower is better within the same type of investment class.
As an example, if your plan offers two different large-cap stock funds to choose from -- one with a 1% expense ratio, and the other with a lower ratio of 0.5% -- it may be worth considering the latter. If it accomplishes the same investment objectives, it may be a good idea to reallocate some of your money.
The bottom line on 401(k) contributions
In a nutshell, the best thing you can do to save for retirement is to contribute as much as you're comfortable with, as early as possible. Your money will never have as much long-term compounding power as it does right now, so take advantage and consider increasing your retirement savings rate as soon as possible, whether you choose to maximize your 401(k) or take advantage of one of the other types of retirement savings available to you.
The $15,834 Social Security bonus most retirees completely overlook If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $15,834 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after.Simply click here to discover how to learn more about these strategies.
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.