One of the best ways that to save for retirement is to take maximum advantage of a 401(k) plan at work. Much more generous contribution provisions apply to 401(k)s than to other retirement accounts such as IRAs, and for most people the 401(k) limits for 2014 will be more than enough to let them save as much as they can toward retirement. But for those lucky few who seek to max out their retirement savings, the news that 401(k) limits in 2014 didn't go up was unwelcome. Let's take a closer look at what the 401(k) limits for 2014 are and why they didn't go up from their 2013 levels.
This year's limits
The limits on 401(k) contributions depend on how old you are. For workers who aren't yet age 50, your 401(k) limit in 2014 is $17,500. Those 50 or older get an additional catch-up contribution of $5,500, making their total 401(k) limit $23,000 this year.
Those 401(k) contribution limits are generous relative to corresponding IRA maximums of just $5,500 and $6,500, respectively. In fact, some might believe that they're so generous that just about no one could max out their 401(k)s. According to the latest triennial release of the Federal Reserve's Survey of Consumer Finances, though, 6.7% of all respondents maxed out their 401(k) contributions. For high-income earners making $100,000 or more, that figure jumped to 28%.
For those who seek to max out their 401(k) contributions, it's natural to want those limits to rise each year. Those who paid attention in past years might wonder why the 401(k) limits in didn't go up for 2014, especially since they jumped by $500 in 2013 and 2012.
Why the 401(k) limits for 2014 didn't go up
The absence of a contribution cap boost involves the way that changes to the 401(k) limits are made. The laws providing for 401(k) plans tie contribution limits to changes in the cost of living, as measured by the Consumer Price Index. During the relevant measuring period for making adjustments to the 401(k) limits for 2014, inflation ran at about 1.5%.
So why didn't the 401(k) limits in 2014 go up by 1.5%? In order to calculate the limits, the tax laws provide that inflation adjustments are made to a base index amount. That index amount is then rounded downward, in this case to the nearest $500 level. Because the base amount for 2014 didn't rise enough to jump over the $18,000 mark, the regular 401(k) limit for 2014 for those under age 50 stayed at $17,500. A similar provision exists for the catch-up contribution, and its index remained below $6,000, necessitating rounding down to $5,500.
Even though savers will suffer the disappointment of unchanged 401(k) limits in 2014, next year should bring a boost for all 401(k) participants. Because the base amounts for the regular and catch-up contributions are now very close to the next $500 increments, it's likely that both will go up in 2015, respectively making the likely levels $18,000 and $6,000. That would mark the first time since 2009 that the two measures both rose in the same year.
For upper-income taxpayers now paying as much as 40% or more in income taxes and surtaxes, maxing out your 401(k) contribution can save thousands of dollars on your tax bill. Making full use of the 401(k) limits in 2014 will ensure that you pay as little in taxes as you legally can.