LAST REVIEWED Apr 13 2020 10 MIN READ
By Damian Davila
There are many tax advantages to putting away your money in a 401(k) or 403(b) every year. Starting January 2018, those advantages are going to get even better!
On October 19, 2017, the IRS officially announced that the contribution limit to 401(k) retirement plans will be increased from $18,000 to $18,500 for 2018. The new contribution limit also affects the very similar 403(b) plan for non-profits, most 457 plans, and the federal government’s Thrift Savings Plan.
How is the 401(k) or 403(b) contribution limit determined?
The IRS uses a cost-of-living (COLA) adjustment schedule to set how much taxpayers can contribute to their retirement accounts. Back in 1989, you could only contribute up to $7,627 to a 401(k). To account for increases on the cost of living, as measured by the Consumer Price Index and other factors, the IRS bumps up the contribution limit as needed. Since 2015, the contribution limit has stayed steady at $18,000, so many were eagerly awaiting the next (inevitable) bump.
Here are some highlights of the history of 401(k) contribution limits:
|Year||401(k) Contribution Limit|
What about catch-up contributions? (The $24,000 limit is now $24,5000)
In its official announcement, the IRS stated that the catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), most 457 plans and the federal government’s Thrift Savings Plan remains unchanged at $6,000. Even if you don’t turn 50 until December 31, 2018, you can still make the additional $6,000 catch-up contribution for the year.
Is it a good thing that I can save more with my 401(k)?
Yes, and for many reasons!
First of all, when it comes to retirement, saving more is always better. In 2017, you could save $7,000 more for retirement than a worker did back in 2002. Just accounting for inflation, $18,000 in 2017 is worth more than $11,000 in 2002. According to the CPI Inflation Calculator from the U.S. Bureau of Labor Statistics, $11,000 in January 2002 has the same buying power as $15,330.37 in September 2017. Being able to sock away more for retirement is beneficial to account for higher living costs during your retirement years.
Second, a $500 bump in retirement savings may seem little but it can go very far (compound interest!). Assuming a 7% annual return rate on your 401(k), let’s see how much you would have by contributing $500 to your plan per year at different holding periods (see the table below). Over a 20-year period, an extra $500 per year can build up to $21,266.92 in a 401(k) with an annual return of 7%.
|Holding Period||401(k) Balance||Interest Gain|
Third, the current administration is putting several tax deductions on the chopping block. Proposed changes in 2017 to the tax code (it’s been a tumultuous year) by would eliminate the state and local tax deductions, which would hurt workers living in states with high taxes. Taxpayers who counted on itemizing deductions on their return would be worse off taking a smaller standard deduction. Every dollar in a 401(k) reduces your taxable income and effectively lowers your tax liability. With a $18,500 contribution limit in 2018, a couple filing taxes jointly could reduce its combined taxable income by up to $37,000 next year.(Speaking of 401(k)s and taxes, here’s the answer to Do I Need to Do Anything Special on My Taxes for My 401(k)?)But for now, you can rest easy, since President Trump’s tweet on October 23, 2017 stated that he intends to keep the 401(k) tax deduction intact.
Can I start contributing $18,500 to my retirement plan today, for 2017?
No, you have to wait until January 1, 2018 to start contributing that extra $500. In 2017, the contribution limit remains at $18,000. You want to avoid all excess deferrals on your paycheck because of harsh tax penalties. Keep in mind that employer contributions, such as matching contributions, don’t count towards the limit.
Due to the delay in 401(k) accounting by most plan administrators, you may not find that you have withheld too much from your paycheck for your 401(k). The good news is that the IRS gives you until April 15, 2018 to withdraw any excess contributions. Make sure to request your plan administrator to adjust your excess deferral withdrawal for any gains or losses. Under this scenario, you won’t pay taxes on the original contribution, pay applicable income taxes on any gains on the year of withdrawal, and are not subject to the additional 10% tax on early distributions. Make sure to collect Form 1099-R from your plan distributor to file your return. This will document your withdrawal of excess deferrals.
If you contributed too much to your 401(k), don’t miss the April 15, 2018 deadline. The IRS indicates that you would pay taxes twice on excess deferrals left on your plan beyond that date: once when contributed and again with distributed. Double taxation is never a good thing.
So, what if you do want to save more than your 401(k) contribution retirement limit? Then, you could save up to $5,500 ($6,500 if age 50 and over) in 2017 and 2018 with an IRA. Check out these articles to learn more about traditional and Roth IRA plans:
Are there any other important changes affecting my 401(k) or 403(b) in 2018?
Increase in Income Limit for Saver’s Credit
There is a great piece of news for retirement plan holders who are currently using or planning to use the Retirement Savings Contributions Credit, better know as the Saver’s Credit. The income limits for the Saver’s Credit have been bumped up.
Income Limit for Saver’s Credit
|Type of Taxpayer||2018||2017|
|Single and married individuals filing separately||$31,500||$31,000|
|Heads of household||$47,250||$46,500|
|Married couples filing jointly||$63,000||$62,000|
To learn more about the Saver’s Credit, check out: 401(k) Saver’s Credit: A Step-by-Step Guide to Reducing Your Tax Liability.
Increase in Contribution Limit for Solo 401(k)s
The annual contribution for a solo 401(k) is $55,000 in 2018, up from $54,000 in 2017.
In 2018, you can contribute up to $18,500 ($24,500 if you’re age 50 or older) as an employee and you can also contribute up to 25% of your net self-employment income for the year as an employer. The total annual contribution from both sources can’t be greater than $55,000 or $61,000 if age 50 or older.
Here is our guide on everything you need about solo 401(k) plans.
Confusion around significant decreases: Proposed Republican tax bill
You may have seen in the news that there’s lots of talk about a steep decrease to 401(k) contribution limits that’s being proposed — as low as $2,400! While this is far from fully confirmed, it’s something to keep in the back of your head. We’ve written more extensively on that topic and recent updated about it here.
We hope you found this helpful! There’s a lot moving and shaking in the 401(k) space, and we encourage staying on top of the news and learning about how these changes affect you and your savings.
Damian Davila is a Honolulu-based writer with an MBA from the University of Hawaii. He enjoys helping people save money and writes about retirement, taxes, debt, and more.