When it comes to providing for our retirement, most of us have to mostly rely on ourselves. The average Social Security retiree benefit check this year is a measly $1,328 per month as of January, which is only about $15,900 per year, and fewer and fewer of us have pensions. Thus, we need to save. Tax-advantaged retirement accounts such as 401(k)s can help, but first you need to know what the 401(k) contribution limits are, and whether you should aim to max them out.
First, though, let's review how important this issue is. According to the 2014 Retirement Confidence Survey published by the Employee Benefit Research Institute:
- Only 57% of American workers (or their spouses) were saving for retirement in 2014, down from a recent peak of 65% in 2009.
- Fully 73% of American workers have no retirement plan.
- More than a third of Americans, 36%, have socked away less than $1,000.
If you're not among the woefully underfunded Americans, that's great. But whether you are or not, you can probably benefit from saving and investing aggressively for retirement -- either to create a comfortable one for yourself or a very comfortable one.
401(k) contribution limits
So what are the limits, exactly? Well, you can sock away up to $17,500 ($23,000 if you're 50 or older) in a 401(k) plan in 2014, and $18,000 ($24,000 for those 50 and up) in 2015. Note, too, that the deadline for each year's contribution is Dec. 31 of that calendar year.
It's worth noting another set of contribution limits -- for IRAs. You can contribute up to $5,500 in IRAs per year in both 2014 and 2015, plus an extra $1,000 in "catch-up" money for those 50 and older.
Why max out the 401(k) contribution limits?
The 401(k) contribution limits are steep enough that maxing them out will be difficult for many people. If you earn, say, $50,000 per year, contributing $23,000 amounts to nearly half your income (pre-tax). Still, plenty of people earn enough to be able to max out their 401(k)s, or they're part of a two-income household, which can make things easier.
The case for maxing out your 401(k) contributions each year -- or coming as close to that as you can -- is simple: Many people need to be saving and investing aggressively, and 401(k)s offer valuable tax advantages to help with that. The traditional 401(k) works much like a traditional IRA: You contribute pre-tax money, which lowers your current taxable income. Then, when you withdraw money from the account in retirement, it's taxed at your ordinary income tax rate at the time -- which may well be lower than your current tax rate. If you earn $75,000 and manage to sock away $20,000, your taxable income falls to $55,000, shaving a lot off your tax bill.
There's a newer kind of 401(k) now, too, increasingly offered by employers: the Roth 401(k). It works much like a Roth IRA, accepting post-tax dollars that do nothing for your current tax bill, but letting you withdraw all funds from it in retirement tax-free.
A final consideration is that many employers offer matching contributions to your 401(k). If yours does, you should absolutely contribute at least enough to get all the matching funds you can.
Why you might not want to max out your 401(k) contributions
Despite all that, you might not want to aim to max out your 401(k). That's because you might want to funnel more money to your IRA, as IRAs offer more flexibility in investments, letting you invest in any of thousands of stocks, bonds, and mutual funds. The typical 401(k) is much more limited, usually offering just a handful of funds.
Thus, if you can't max out contributions to both your 401(k) and your IRA, consider first putting as much as needed into your 401(k) to grab all available matching funds, then contributing your next dollars to your IRA until that's maxed out, and then moving back to your 401(k) with any remaining available contribution dollars.
Think about your situation, though, and what your best strategy would be.