| Thanks to a higher-than-normal annual inflation rate of 5.4%, the IRS will allow workers to contribute up to $20,500 to their 401(k) plan and some other retirement accounts in 2022, a $1,000 boost from 2021 contribution limits.
Does this news make you very excited and want to max out your 401(k) plan?
After all, it seems to be obvious that you have one very simple reason to max out your 401(k): The more you contribute, the bigger your retirement savings account will be. Right?
As a betting man, I would wager that's not going to be the case for a majority of people who are invested in their company's 401(k) plan.
To be sure, larger contributions will allow you to defer more income from taxation. By and large, this will be great for high-income Americans who are facing potentially higher taxes next year under tax proposals from President Biden's Build Back Better plan. It's not a strategy that everyone will be able to handle. In fact, only a fraction of people – 8.5% – who funneled money into a defined-contribution account hit the maximum in 2018, according to a Congressional Research Service report.
So, should you max out that 401(k) plan? It depends.
Here are some pros and cons to consider.
Pros: it will help reduce your taxable income; it obviously helps you save enough to retire some day; and you allow the magic of compound interest a chance to do its job.
Cons: You may tie your money up in illiquid assets; maxing out your retirement plan can prevent you from paying off high-interest debt; you may be investing in a company plan that isn't very good. (In this case, you might want to consider investing just enough to get your employer's match, then invest in something else, like index funds.)
Once you've taken the pros and cons into consideration, figure the amount you need for retirement and consider your risk tolerance. Next, decide on the 401(k) savings amount that works best for you. You may not feel comfortable with maxing out your retirement, and that's your call.
What percentage should you look to contribute to a 401(k)? In general, personal finance experts suggest saving at least 15% of your annual income for retirement throughout your working career.
Experts also say that your contributions should be based on a percentage of your income, depending on your age. They suggest that you should stash away 10% to 15% of your gross income if you're in your 20s and 30s. If you're behind in retirement savings in your 40s and 50s, many experts encourages you to set aside between 15% to 25% of your income.
Of course, one common best practice is to contribute at least the minimum required to capture your employer's 401(k) match, if one is provided. You'll gain the full benefit of the match without leaving any free money on the table.
For more cool stuff like this, check out CNBC's Financial Advisor Hub and CNBC + Acorns Invest in You: Ready. Set. Grow. |
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