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March 9, 2021

401(k) Contribution Limits for 2021: All You Wanted to Know

If you have a practical approach to retirement savings or are looking for the ways to boost your savings game this year, you probably know that the retirement contribution limit remains the same for 2021. Still, there are a couple of things worth taking into account, whether you’re already saving or just getting started. Stay with us to read about 401(k) contribution limits for 2021 in more detail and find answers to the most common questions concerning 401(k). 

401(k): a Brief Overview

Before we go any further, let’s brush up on what 401(k) means. In short, 401(k) is a retirement savings plan sponsored by an employer where employees can choose how much they contribute. 401(k) enables workers to save and invest a part of their paycheck before taxes are taken out. Although it depends upon the type of 401(k) contribution, you can defer taxes until the money is withdrawn from the account.

Types of 401(k) Retirement Plans

Employers can offer their employees the following types of 401(k) plans:

  1. Traditional 401(k) plans
  2. Safe harbor 401(k) plans
  3. SIMPLE 401(k) plans
  4. Solo 401(k) plans
  5. Roth 401(k) plans

Actually, most retirement plans are typically combined with the other ones. For instance, you can have a traditional 401(k) plan and a Roth 401(k) plan at the same time.

Types of 401(k) Contributions

Most 401(k) plans let you contribute to your plan in each of the next ways:

  1. 401(k) pretax contributions. Money is deducted from your annual taxable income, and you pay taxes only when you take it out.
  2. Roth 401(k) contributions, also known as designated Roth 401k account. Dollars get into the Roth 401(k) account after you pay taxes, and consequently, the withdrawal is tax-free.
  3. After-tax 401(k) contributions. Like a Roth 401(k), an after-tax 401(k) contribution is made after taxes have been paid, and your earnings grow tax-deferred. Still, unlike a Roth 401(k), the money on the account gets taxed upon withdrawal. 

401(k) Contribution Limits for 2021

As we have already mentioned, the 401(k) contribution limit stays the same for 2021, however, a few of the income limits for a 401(k) plan have grown. Have a look at the following numbers to make a more informed decision while considering retirement savings in 2021:

  1. the 401(k) contribution limit: $19,500;
  2. the 401(k) catch up contributions limit for employees aged 50 and older: $6,500;
  3. the limit for employer and employee contributions: $58,000;
  4. the 401(k) compensation limit: $290,000;
  5. the income limits for the saver’s credit for individuals; $33,000;
  6. the income limits for the saver’s credit for couples: $66,000.

All in all, the maximum you can put into a 401(k) for 2021 is $19,500 if you’re under the age of 50, and $26,000 if you’re 50 years old or beyond.

How Much to Contribute to a 401(k)

Undoubtedly, a 401(k) plan is a great way to save for retirement. Still, due to the fact that 401(k) plans are tax-advantaged, the Internal Revenue Service establishes a limit on how much you (as well as your employer) are able to invest into your 401(k) annually.

It goes without saying that it’s best when you can save as much as possible (without exceeding 401(k) contribution limits of course). At least, you should try to put in your 401(k) plan enough dollars to obtain all possible employer contributions, the money your employer contributes to your retirement savings plan based on the amount of your own contribution.

Let’s say there are two employees, each of them earning $100,000 annually, receiving 3% raises and earning 5% on the 401(k) plan. One of them contributes 5% of the salary annually, while the other gives 8%. In twenty years, the first employee will obtain $222,386, and the second one will have $355,818. As you see, increasing your savings is a great strategy to accumulate more dollars.

In addition, if you feel that you can afford to save more, add to your savings by utilising the catch up contributions when you're over fifty. It enables you to make bigger savings as you're getting closer to your retirement.

In case you can't afford to scale up your 401(k) at the moment, don't back away. Many companies offer their workers an ‘auto-increase’ feature that adds to your fund automatically by 1% at the end of the calendar year until you achieve a cap rate of 10-15%. So if your employer offers this option, don’t waste this opportunity.

How to Invest 401(k)

There is a common belief that investing might be risky, but you risk holding cash as well. Not only taxes, but also inflation can reduce your savings in the end. So it’s definitely a wise idea to put your money to work. 

First of all, decide where your dollars will be invested. Next, decide how much risk you’re comfortable with. As a rule of thumb, you can subtract your age from 110 to figure out the percentage of your portfolio to invest in equities; the rest should be in bonds. Get this: stock funds are split into categories. Your 401(k) will be likely to offer at least one fund in each of the next categories: U.S. large cap, U.S. small cap, international, emerging markets and sometimes alternative options like real estate or natural resources. It’s best to diversify your portfolio by distributing the money you want to allocate to equities across these funds.

Sounds too complicated? Remember: it’s always a good idea to hire a certified financial planner to help you manage your finances and avoid issues.

How to Get Money Out of Your 401(k)

It goes without saying that as your 401(k) money is meant to be used after you retire. However, there are circumstances due to which you may take accumulated money out of a 401(k) without facing any penalty. However, keep in mind that you'll still have to pay taxes. Here are circumstances due to which you can start using your accumulated 401(k) employee contributions, roth 401(k) money and catch up contributions:

  1. you get to 59.5 years of age;
  2. you retire/quit/are dismissed anytime after you turn 55;
  3. you become disabled;
  4. you need money to avoid foreclosure from your home;
  5. you have to pay for college tuition;
  6. your beneficiary needs to take out the funds when you pass away;
  7. you need cost to pay for a funeral;
  8. you need money to cover medical expenses.

Withdrawal Penalty

If you aren’t eligible for a penalty free withdrawal, you can still cash out your 401(k) money even if you haven’t reached the age of 59.5. However, withdrawing funds early can carry serious financial penalties. Also, get this: not every employer permits early 401(k) withdrawals, so make sure to check with your HR department whether this option is available.

As of 2021, if you are under the age of 59.5, a withdrawal from a 401(k) is subject to a 10% penalty. In addition, you’ll be required to pay your regular income taxes on the withdrawn funds. For instance, for a $10,000 withdrawal minus taxes and penalties, you’ll only get around $6,300.

The Bottom Line

All in all, contributing into a 401(k) retirement plan is a good strategy to save up for the time when you retire. It’s a good idea to put the maximum amount of money possible in your retirement plan, but bear in mind the limits for 401(k). As of 2021, the contribution limit is $19,500 for employees under 50 and $26,000 if you’re 50 years old or beyond. However, you can save up more by investing your 401(k), so don't hesitate to get in touch with a certified financial planner to help you maximize your 401(k).

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