Some of you may contribute to your 401(k) to stay on track for financial freedom. Others are motivated by the huge tax savings that come with maxing out their 401(k) plans each year. There is probably a group of 401(k) contributors who have yet to learn why they are doing it beyond someone telling them it was something they should be doing.
Keep reading as we share the five benefits of supercharging your 401(k) contributions.
401(k) Contributions Will Lower Your Tax Bill
Your contributions to a 401(k) plan are made pre-tax, meaning you don’t pay income taxes on money put into your 401(k) that year. This will help lower your overall tax bill each year. As a bonus, this reduction in taxable income may help you qualify for stimulus payments and child tax credits or drop your income enough to avoid the Obamacare Surtax on investment income. Plus, saving for retirement will help you have a better retirement in the future.
Contributing More Into Your 401(k) Can Help You Retire Earlier
Have you heard about financial freedom? The day when work becomes an option. Well, larger contributions to your 401(k) can help you reach financial freedom faster. Even if you love what you do, having the option to choose to go to work each day can be pretty liberating.
Potential Free Money From Your Employer
If your boss asked, “Can I increase your salary?” I’m almost sure that most people would say, “YES!” By not getting your full employer match, you are essentially saying NO! to a raise.
The employer match on your 401(k) is like free money from your boss (or at least your employer). In many cases, your employer will match your contributions to your 401(k) dollar for dollar up to a certain amount of income. This is like doubling your money overnight. For the average American worker, skipping the employer match could be a million-dollar retirement mistake. For those with above-average incomes, the cost could be even higher.
Let Compounding Interest Grow Your Retirement Income
For many people, becoming a millionaire seems entirely out of reach. Given enough time, anyone can become a millionaire. The reality is many of you will want to become multi-millionaires to maintain your standard of living in retirement.
Becoming a millionaire is easier than you think, at least with the help of time and compounding interest. You could become a millionaire over your working life by saving just $140 per month. This assumes you work from age 22 to 65 and earn an average of 10% yearly on your investments. This gets even easier if you work for a company that provides an employer match and you take advantage of the tax savings of a 401(k) plan.
If you have a dollar-for-dollar company match, your monthly contributions are cut from $140 to just $70 per month to become a millionaire. After taxes, you would likely only see your paycheck drop somewhere between $44-63 per month. The drop could be smaller depending on your state income-tax rates and overall income.
By comparison, if you wanted to retire a millionaire at age 50, you would need to save around $2,625 monthly. Employer match could help lower this amount, but it would likely be a much smaller portion of the total saved than the scenario where you started investing for retirement at age 22. Start early and let compounding interest do much of the heavy lifting when it comes to growing your net worth.
New 401(k) Contribution Limits For 2023
The contribution limits for the 401(k) plan have increased for 2023. If you want to max out your 401(k) in 2023 as an employee, you can contribute $22,500—an increase of $2,000. For workers over 50, the catch-up 401(k) contribution is now $7,500 per year.
For all the business owners who can contribute as both employees and business owners, 401(k) limits have increased by $5,000 for a total of $66,000 per year. Business owners aged 50 or older can also make a $7,500 catch-up contribution for a total of $73,500. Actual 401(k) contribution limits will depend on your income, the number of employees, and how the 401(k) plan is set up. So, talk with your tax-planning financial planner about properly setting up your 401(k) to maximize the benefits for you and your family.
For business owners reading this who are already maxing out their 401(k), check out the Cash Balance Pension Plan. You could potentially contribute an additional $245,000 pre-tax to this awesome tax-saving retirement plan. This could mean sheltering over $300,000 of income per year from current taxation between a Profit Sharing plan and a Small Business Pension. These numbers could be doubled if your spouse also works in the business.
Wherever you are today, when it comes to contributing to your 401(k), look for ways to increase the amount you save for retirement, even if you only do it for the valuable tax savings. Supercharge your investments and contributions; you could be on track for financial freedom before you know it.