For the 2018 tax year, the IRS has increased the employee 401(k) contribution limit to $18,500 to keep up with the rising cost of living. This means savers who want to max out their retirement savings have the ability to contribute an additional $500 to their 401(k) account, which also translates to a greater tax break.
Here are the details about 401(k) contribution limits in 2018, and what it could mean for you.
The 2018 401(k) contribution limit
As I mentioned, the 401(k) contribution limit in 2018 is increasing by $500 over the 2017 limit to $18,500. This limit also applies to other qualified retirement plan types, such as 403(b) plans, most 457 plans, and Thrift Savings Plan accounts.
It's important to keep in mind that this is the limit for employee elective deferrals. This is the money you choose to have withheld from your paycheck, and deposited into your IRA. It does not include any non-elective contributions or matching contributions made by your employer.
In addition, there is a catch-up contribution allowed for participants who are age 50 or older, and this remains unchanged, at $6,000 for 2018. So, the maximum elective deferral any employee can choose to make for 2018 is $24,500.
The overall limit for 401(k) contributions, which includes money from all sources, including your employer's matching contributions, is rising by $1,000 to $55,000.
What it means for you
In an immediate sense, the higher 401(k) contribution limit translates into a better possible tax benefit. If you elect to make your 401(k) contributions on a tax-deferred basis (as opposed to Roth 401(k) contributions), this means you can potentially exclude $500 more of your income from taxation in 2018.
For example, if you earn $100,000 and contribute the maximum allowable amount to your 401(k), based on the 2017 limits, you can reduce your taxable income to $82,000. In 2018, a maximum elective deferral would reduce the total to $81,500. For someone in the 25% tax bracket, this translates into an additional $125 in tax savings.
From a long-term perspective, it means savers who take full advantage of the limits will be in a better position to grow their nest eggs over time. Assuming 7% annualized returns, an additional $500 investment could grow into more than $3,800 over a 30-year period.
To be fair, most Americans don't contribute the maximum possible amount to their 401(k), nor do they necessarily need to. In fact, Vanguard found that just 12% of its plan participants contribute the maximum amount. So, unless you're one of these super-savers, the increased contribution limit won't affect you.
How much do you need to save each year for retirement?
Unfortunately, there's not a one-size-fits-all answer to this question. Experts generally suggest that you'll need about 80% of your income after you retire in order to maintain your lifestyle. Some of this will come from Social Security, and your savings will need to produce the rest. By using a few assumptions, you can get a good idea of your ideal retirement number.
Most 401(k) and similar employer-sponsored retirement plans have a savings projection feature on their online portal (or on your paper statements) that can tell you how much you're likely to end up with at your current savings rate. If your projected final retirement savings is significantly below the amount you'll need to live comfortably in retirement, it could be a good idea to increase your contributions.