The maximum contributions you can make to your employer 401(k) retirement savings plan are going up again in 2020. For those younger than 50, the maximum of $19,500 will be $500 higher than 2019's limit of $19,000. If you're 50 or older, you'll be allowed to save up to $26,000 in a 401(k) in 2020 -- $1,000 more than you could in 2019.
2020 marks the second year in a row that retirement investors have enjoyed gains in the maximum contribution amounts for 401(k) plans. Only about 1 out of 8 participants are able to save enough to reach the limits, but it's still smart to look at 401(k) plans even if you can't max them out. Below, we'll look at some of the biggest benefits of 401(k)s, as well as an alternative for those who aren't fortunate enough to have an employer that offers one.
Why 401(k)s are so useful
401(k) plans have a number of helpful provisions that assist employees in their efforts to save for retirement. They include the following:
- Tax savings. Most 401(k) contributions involve employees setting aside pre-tax money toward retirement. The amount of their taxable income thereby goes down by the amount contributed, creating immediate tax savings for the tax year in which you make the 401(k) contribution.
- Employer matching of employee contributions. Many employers are generous enough to match a portion of the money that their employees put into their 401(k) accounts. Common provisions involve employers putting in an extra $0.50 or $1 for every dollar a worker contributes up to 6% of total pay. Those employer matching contributions can add up to thousands of extra dollars in retirement.
- Automatic savings. Employers typically take employee contributions through automatic payroll deduction. That means you never even see the money you contribute hit your paycheck, making it far easier to stay disciplined in your overall retirement savings strategy.
- Access to lower-cost investment options. Employers that set up worker-friendly plans often offer employees access to lower-cost investment options, such as institutional-class mutual funds. The fees on such institutional funds can be considerably lower than what a typical retail investor would pay for the same mutual fund.
Unfortunately, there are some downsides to some 401(k) plans. Some employers choose not to offer high-quality investment options in their 401(k)s, instead restricting their workers to more costly fund options. That doesn't mean you should give up on making 401(k) contributions, but it can offset some of the benefits of using them.
An alternative to 401(k) plans
If your employer doesn't offer a 401(k) plan, you can still save for retirement and get some valuable tax benefits. IRAs are available to anyone with earned income, and you can get many of the same breaks that 401(k)s offer. Traditional IRAs usually let you deduct the amount you contribute from your taxable income in a manner similar to what 401(k)s do.
Still, there are some differences. Contribution limits are lower, with 2019 and 2020 limits of $6,000 for those younger than 50 or $7,000 for those 50 or older. However, unlike 401(k) plans, IRAs let you make prior-year contributions up until the mid-April deadline for filing your tax return. That gives you an extra few months in 2020 to make a 2019 contribution even before you start to consider what your savings strategy for the 2020 tax year will be.
In addition, IRAs don't limit your investment options in the same way 401(k) plans do. You can choose from a wide range of financial providers and can invest in anything from mutual funds and exchange-traded funds to individual stocks and bonds.
Start saving for retirement in 2020
401(k) plans can be helpful in letting you save for retirement, and the modest boost in contribution limits for 2020 will come in handy for some savers. Whether you use a 401(k), an IRA, or a combination of the two, having a retirement savings strategy will serve you well in meeting your long-term financial goals.