Every year, the IRS makes cost-of-living adjustments to the maximum amount you can contribute to your retirement plans. For the first time in two years, 401k contribution limits will rise in 2015 to a maximum of $18,000. That's an increase of $500.
That might sound like a tiny sum, but over time that extra $500 can quickly compound. If, for instance, a 22-year old were to invest this extra $500 every year from now until age 66, he/she would have an additional $263,000 in retirement.
Of course, this is the rosiest of predictions. Few 22-year-olds can meet 401k contribution limits, and, assuming annual inflation of 3%, that extra $263,000 would really be worth about $70,000 in today's dollars come retirement time.
But all too often we focus on only one of the three different 401k contribution limits. When all three are taken together, they can make a much bigger difference in your nest egg than you might imagine.
The other two 401k contribution limits you didn't know about
Even though your elective deferrals are capped at $18,000 per year, those over the age of 50 can add $6,000 more, bringing the total to $24,000 per year. That's up a full $1,000 from last year.
And the total amount you're allowed to have put into your 401k in 2015 is a whopping $53,000 -- also up $1,000 from last year.
But even if you're over 50 and contribute the maximum to your 401k, how in the world can you possibly reach the "Defined Contribution Limit" of $53,000?
Any amount that your employer matches to your 401k is not counted against your "Elective Deferrals." But most matches are capped, usually at $3,000 to $4,000. For our 50-year-old worker looking to supercharge their retirement savings, that still leaves a $25,000 gap.
How to ignore the 401k contribution limits and supercharge your savings
Another way to bridge the gap between the standard 401k contribution limits and the $53,000 threshold is to make after-tax contributions to your 401k.
On the face of it, this doesn't make a lot of sense. The whole point of a 401k is that it allows you to put away money for retirement while reducing your taxable income. If you put the money in after tax, you aren't reducing your taxable income one cent.
But thanks to some research on the part of the Mad Fientist blog, we now know that you can take those after-tax contributions to your 401k and convert them to a Roth IRA in short order. This means that all your savings, including any growth you achieve, can be withdrawn tax-free after the age of 59-1/2.
Not everyone will have a plan that allows after-tax contributions to a 401k, and even fewer allow for in-service withdrawals -- which means you might have to wait until you leave your job to convert to a Roth.
The bottom line, however, is simple: The IRS is bumping up 401k limits in 2015, and if you are able to reach your limit, then you will be much closer to reaching your retirement goals.