The 401(k) Contribution Limit Is Increasing in 2020

The IRS just announced its latest inflation adjustments for 2020, and one of the most significant for investors is the upward adjustment in the contribution limits to 401(k) and other qualified retirement plans. With that in mind, here’s a discussion of just how much more you can legally save in your tax-advantaged employer retirement plan and how much you should be saving for your own retirement.

The 2020 401(k) limits
For 2020, the annual contribution limit for elective deferrals to a 401(k), 403(b), 457, or Thrift Savings Plan is rising by $500 to $19,500.

And keep in mind that this is the limit for elective deferrals, meaning the money that you as an employee choose to contribute to the plan.

It does not include any nonelective employee contributions, any contributions (matching or otherwise) that your employer makes on your behalf, or any allocations of forfeitures.

If you are 50 or older, you also qualify to make elective catch-up contributions.

For 2020, this is rising to $6,500 from the previous limit of $6,000.

And to be clear, this is in addition to the general elective contribution limit, so for plan participants age 50 or older, the 401(k) elective deferral limit is $26,000 in 2020.

Finally, the overall contribution limit to a qualified retirement plan is rising to $57,000, a $1,000 increase from 2019. This includes elective deferrals, nonelective deferrals, employer contributions, and allocations of forfeitures. It does not include catch-up contributions if you’re eligible, so the overall limit is actually $63,500 in 2020 if you’re 50 or older.

If this sounds confusing, here’s a quick reference chart:

How much should you contribute to your 401(k)?
To be sure, if you have the means and desire to contribute as much to your 401(k) or other qualified retirement plan as you’re legally allowed, we certainly encourage you to do so. However, it’s often not practical (or necessary) to save $19,500 (or $26,000) in a single year.

With that said, here are a couple rules of thumb that could help you determine how much to contribute:

At a bare minimum, you should contribute enough to take full advantage of your employer’s matching contributions. For example, if your employer will match half of your contributions up to 6% of your salary, 6% is the absolute least you should contribute. Anything less is literally turning down free money.

If your goal is a comfortable retirement, you should contribute a minimum of 10% of your salary to your retirement accounts, not including any employer matching contributions. This doesn’t all have to be in your 401(k) — for example, if you want to save some money in an IRA to invest in specific stocks or funds, that’s a good idea as well, as long as you’re not leaving any matching contributions on the table.

For example, let’s say that you earn $60,000 in 2020 and that your employer will match 100% of your 401(k) contributions up to a maximum of 5% of your salary. Based on the rules of thumb listed above, you should plan to save at least $6,000 — 10% of your salary. At least $3,000 of this should be saved in your 401(k) in order to take full advantage of your employer’s match.

The bottom line is that the tax breaks and advantages of retirement savings are some of the most valuable available to Americans, and thanks to inflation adjustments like the one the IRS just announced, the 401(k) contribution limit gives most investors a lot of room to take advantage and increase their retirement savings.

— Matthew Frankel

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Source: The Motley Fool