In 2021, only 14% of participants reached the 401(k) contribution limit, according to a Vanguard study. And this year, maxing out your account will be an even bigger feat. If you have the means to do so, however, you can take full advantage of the benefits this retirement account has to offer.
What’s New in 2023
The 401(k) contribution limit for 2022 was $20,500 ($27,000 for people age 50 or older). In 2023, 401(k) owners can contribute even more, with the maximum contribution limit being $22,500. If you’re 50 or older, you can contribute an additional $7,500 in catch-up contributions for a total of $30,000.
Why Max Out?
With such a significant increase, you may be wondering whether you should max out your contributions. Ultimately, it all depends on your financial situation, but there are a handful of reasons maxing out your 401(k) may benefit you.
You can lower your 2023 tax burden.
One of the main reasons people choose to max out their 401(k) is to lower their annual tax burden. If, for example, you earn $90,000 in 2023 and put $22,500 into your 401(k), you would only owe taxes on the remaining $67,500. You’ll need to pay taxes when you make withdrawals in retirement, but maxing out your 401(k) can help you save big on taxes in the short term.
More of your money can grow tax-deferred.
With a 401(k), like with all retirement accounts, time is your greatest ally. The sooner you can add more funds to your 401(k), the more you can benefit from tax-deferred growth. Because you contribute pre-tax funds, the money you would’ve spent on taxes stays in your account, where it compounds and grows, potentially giving you a major boost in your retirement savings.
You can make a larger investment for your future.
You likely have a long list of financial goals. While maxing out your 401(k) may not feel like a top priority right now, you’ll be thankful for your contributions when it comes time to withdraw.
How much can your 401(k) grow over time? Let’s say you currently have $0 in your 401(k) and earn a $90,000 annual salary. You save $22,500 (25% of your salary) and receive a 50% employer match on up to 6% of your salary. Assuming you get a 3% annual salary increase and an 8% annual rate of return, your 401(k) could grow to $1,189,642 with a 20-year time horizon.
When Should You Not Max Out?
Despite the benefits, maxing out a 401(k) may not be feasible for everyone. If, for example, someone makes $50,000 each year, contributing the maximum $22,500 would leave them with less than $30,000 to live on, which may not be sufficient, especially in areas with a high cost of living. When deciding how much you can contribute, consider whether you’ve hit other key financial goals, such as creating a six-month emergency fund and paying off high-interest credit card debt.
Even if maxing out your 401(k) doesn’t make sense for you in 2023, it’s always a good idea to take advantage of any employer match (offered referred to as “free money”). Let’s assume your employer offers a 100% match on up to 4% of your salary. If you earn $90,000, your employer will match your contributions up to $3,600.
Still not sure if you should max out your 401(k)? Get all of the personalized retirement strategies you need with our comprehensive financial planning services. Contact us today to get started.
