Starting 2019, retirement savers in the U.S. will be able to contribute $500 more to their 401(k) individual retirement accounts and an additional $ 500 to their IRA accounts.
This is the first such increment since 2013 which will also see contributors qualify to claim the retirement saver’s tax credit.
Every once in a while, the IRS pronounces changes on the permissible contributions an individual can make on their retirement savings accounts. These changes are often hikes and are in line with the rising cost of living along with several other economic considerations.
However, these hikes are not binding to private funds or other private individual retirement saving plans, but they can influence significantly.
The changes have an impact on your current pay, and how much income tax you can defer paying and if you invest your 401(k) wisely, how much you can accrue.
Here’s how the retirement account rules will change in 2019 and what these changes mean for you.
Changes in 401(k) Contributions
In 2019, the new 401(k) contribution limit will be $19,000. This is a hike from the previous $18,500 in 2018. Also, contributors who are 50 years or older and expect to hit the 401(k) elective deferral limit can contribute an additional $6,000 in catch-up contributions.
However, the catch-up contributions are not subject to the cost-of-living adjustment and remain unchanged at $ 6,000 per year. Also, the IRS has revised limits on contributions from any source.
If you are under 50, the limit is revised from $55,000 in 2018 to $56,000 in 2019. If you’ve crossed the 50-year mark, your limit will be $62,000 up from $61,000.
What Do These Hikes Mean
These hikes have an impact on how much you can contribute. Therefore affects how much you can accrue in your retirement account and the amount of tax you can defer.
A Higher Contribution Allowance
The increase means you can max out your contribution allowance for the 401(k) at $19,000 and $ 6,000 for the IRA, making your total contribution allowance $ 25,000 for 2019.
Employees who work for companies with “matching plans” get a double advantage. Many employers with such plans often give $0.50 for every dollar contributed by the employee.
Meaning, if you earn $ 50,000 and you contribute 5% ($2500), the employer will contribute an extra $ 1,250 each year. This is free money that doesn’t add to the annual contribution limit!
Secondly, since the limit for contributions is higher, employees can now ‘stash away’ more cash and expect a higher corresponding contribution from their employers. You can put in an extra $1,000 into solid investments and expect a $500 boost from your employer on each year.
This is a big deal, especially for younger workers. Consider the example below.
Say you are 25 years old, and you max out your retirement savings contributions for the next 35 years at $ 25,000 each year. You’ll stash a staggering $ 665,000 in 401(k) before interest.
If you invest your 401 (k) wisely at a modest interest of 6 percent, your retirement nest egg will exceed three million dollars before you hit 60!
But let’s be real. Few 25-year-olds can put away that much money into building a retirement nest egg. An annual retirement savings contribution of $ 25,000 means taking out from your pay, slightly more than $ 2,000 each month.
Moreover, if you get paid bi-monthly, like many American millennials, you’re glaring at a jaw-dropping $1,050 deduction from each paycheck!
If that’s you, and you don’t have the benefit of an employer match, consider starting off at a five percent contribution on each paycheck. Then you can progressively increase your contributions to the lofty 20 percent contribution over the years.
Moreover, there are several other ways you can make money without compromising your 9 to 5. Check out TaskRabbit for stuff you can do and get paid and add to your contributions and watch them grow exponentially over the years to give you a stress-free retirement.
Changes on the Taxes on Your Paycheck
It is essential to understand that contributions made to a traditional 401(k) account are on a pretax basis. This means that if you contribute more, you’ll have a lower taxable income.
Therefore, you’ll pay less federal taxes and your take-home pay will decrease. Nevertheless, the decrease in take-home pay is not significant considering the benefits.
When you know how to invest your 401 (k) wisely, a lower taxable income is not the only benefit of a higher contribution to the 401 (k) accounts. Your 401(k) dividends and capital gains also accumulate on a tax-deferred basis. That is to say, earnings in your 401(k) are not subjected to taxes unless you make an early withdrawal from the plan.
Also, many people considerably reduce their income levels after retirement.
Therefore, if you don’t make a withdrawal on your 401 (k)until after you are retired, you’ll be in a lower tax bracket and attract fewer taxes.
Therefore, even where the company is not offering an employer plan, it is important that you start contributing to a 401(k) account early.
Employees who cannot access a 401(k) plan or a similar retirement account through their employers have an option. They are eligible to contribute to a tax-deductible retirement account notwithstanding how much they earn.
However, high-income earners who qualify for a 401(k) plan may be limited from claiming an additional tax deduction on an IRA contribution.
Individuals who make contributions to 401(k) accounts cannot claim a tax deduction for a 2019 IRA contribution if their annual income exceeds $74,000. The same applies to couples whose annual earnings exceed $123,000 and file jointly as a married couple.
You can learn more about how to invest your 401 (k) wisely, and how you can maximize your investment by getting in touch with Blooom.
Changes in Roth 401(k) and Roth IRA
Unlike the traditional 401(k) which is funded by pre-tax dollars and future withdrawals are taxable, the Roth 401(k) is funded by after-tax dollars and future withdrawals don’t attract taxation.
It is best for people who foresee a situation where they’ll be in a higher tax bracket after retirement than the bracket they are in right now.
If you have the option of a Roth 401(k), an additional contribution to such a plan will directly affect your paycheck because the contributions are made after deduction of income tax.
Therefore it will significantly lower your take-home pay. Nevertheless, an additional contribution to the Roth 401(k) also has benefits.
The biggest benefit is that, since it relies on post-tax dollars, earnings and withdrawals are not taxable as long as they can be justified as genuine Roth 401 (k) contributions.
Low-income earners who anticipate to higher income, thus higher tax brackets, will end up saving you tons of cash in taxes when retiring.
However, for individuals facing retirement in the near future – say 15 or fewer years – the plan may not be so suitable.
The same applies to a Roth IRA account. Contributions are made on post-tax dollars each year thus, subscribing to such a plan will not reduce the amount of taxable income.
However, you will have the advantage of not paying taxes on your earnings, and withdrawal once you hit retirement age.
If your employer offers a Roth 401(k), it is worth careful consideration.
On the same breath, the IRS increased the 2019 income limits for Roth IRA. Individuals can earn an extra $ 2,000 (and couples an extra $ 4,000) and remain eligible.
However, the IRS capped eligibility to the Roth IRA plans in 2019 to individuals not earning more than $ 122,000 and couples not making over $ 193,000 annually.
Additional Benefits of the Adjustments in the 401(k)
In addition to the increased value of investments and the deferred taxes, the 401(k) has an additional benefit for those struggling with debt.
The 401(k) is considered a qualified under the ERISA (Employee Retirement Income Security Act) which means that they are protected from judgment creditors.
In addition, 401 (k) also provide some protection against federal tax liens.
Therefore, the more you stash away, the more it multiplies and your nest egg is protected from creditors and to some extent tax liens!
Fringe Benefits Limitation for 2019
One of the most significant costs to consider during retirement is healthcare costs. You’ll be wise to start planning for healthcare costs during retirement well in advance.
Apart from Medicare, Uncle Sam offers tax incentives when you contribute to Health Savings Accounts. Therefore, increasing your contribution to a HAS is a smart way to start hedging your nest egg.
Along with the adjustments in 401(k) and IRA, the IRS pronounced a hike for individual and family contributions to Health Savings Accounts.
Individual account contribution limits will increase by $ 50 to $ 3,500. Family contributions limits will rise by $ 100 to $ 7,000.
However, the IRS is yet to announce adjustments to the pre-tax pay reduction limit for health Flexible Spending Accounts from the 2018 limit of $2,650.
The Bottom Line
The adjustments pronounced by the IRS on your 401(k) and IRA contributions will help you stash away more cash into your nest egg each year.
You can also draw more free money from your employer and put it in solid investments which are protected from creditors and other adversities.
Make a smart move by enhancing and investing your 401(k) and IRA wisely.