With less than 3 weeks till the end of the year, now may be your last opportunity to contribute to your retirement account. And why should you do that, especially at a time of year when you probably have a bunch of other expenses?
Because aside from saving and investing for your future, contributing to a qualifying traditional retirement account allows you to reduce your taxable income. And reducing your taxable income means more money in your pocket, not Uncle Sam’s.
Retirement Contributions
Here are the amounts you can contribute with an employer-sponsored retirement plan such as a 401(k), 403(b), and most 457 plans this year:
As an employee, you can contribute up to $19,500 in 2020 towards your retirement account. If you are 50 or older by year-end, you can contribute an additional $6,500 a year for a total of $26,000.
If you are lucky enough to have your employer match a percentage of your contributions, now might be the time for a lump-sum contribution. Don’t make the mistake of leaving money on the table just because you are unclear on what your employer is offering. Not taking full advantage of an employer match is like turning down a bonus or a salary increase.
Yes, we can relate if your eyes glaze over during the benefits presentation at your workplace. Don’t be embarrassed to call your HR department and ask them to explain how the company match works in the most basic terms. If they give you a formula or percentage that you don’t understand, be direct and ask, "How much money do I need to contribute to receive the full match amount?"
“Not taking full advantage of an employer match is like turning down a bonus or a salary increase.”
An employer match does not count towards your contribution limit of $19,500 (or $26,000 if you're 50 or older). There is, however, a maximum amount both you as the employee and your employer can contribute. The maximum combined amount is $57,000 for the year. Again, if you're over 50, there is an additional “catch up” amount of $6,500 for a total annual contribution of $63,500.
Ideally, you should be making regular retirement contributions throughout the year, but if you haven’t been doing that or having been maximizing your contributions, now is a great time to catch up. If you want to make a contribution to your retirement account to reduce your taxable income and take advantage of any employer match and you still have a paycheck coming to you before year-end, you may be able to change the contribution amount on your final paycheck this year by contacting your HR department.
Before making a large contribution to your retirement account, remember to calculate the amount you'll need to cover your monthly expenses. You'll also want to make sure that this lump sum contribution doesn't carry over to next year. You will need to specify to your HR department that you want to return to smaller contributions on subsequent paychecks for 2021—and if you haven’t set up monthly contributions at all, now is a great time to do it.
“You may be able to change the contribution amount on your final paycheck this year by contacting your HR department.”
What If I Have Multiple Employer-Sponsored Retirement Accounts Available to Me?
The employee contribution limit of $19,500 applies to all employer-sponsored retirement plans combined. So if you have both a 401(k) and 403(b) available to you, you will not be able to exceed a total of $19,500 for the combined total. The only exception to this is a 457(b) plan. 457(b)s are retirement plans offered by non-profit organizations. They are often available for employees in education or healthcare. The 457(b) plan has a separate limit that includes an additional contribution amount of up to $19,500.
What If I Do Not Have Access to an Employer-Sponsored Retirement Account?
There are several options to consider if you are not eligible for an employer-sponsored retirement account. You may be eligible for an Individual Retirement Account (IRA). Eligibility is based on both your income and whether you and your spouse are covered by a retirement account through your workplace. You can claim a deduction with a Traditional IRA if you qualify, and you have the added perk of being able to contribute up until the tax filing deadline of the following year. Here is more from the IRS website on Traditional IRA and Roth IRA eligibility. The maximum annual contribution to an IRA for 2020 is $6,000 ($7,000 if you are 50 or older). There are also additional options for self-employed workers such as SEP IRAs and solo 401(k)s to consider for retirement savings.
Looking to the New Year:
For 2021, the individual employee contribution amount remains at $19,500 if you are under 50 and $26,00 if you're 50 or older. The only change is that the maximum limit for employee and employer contributions combined is increasing from $57,000 to $58,000. For those 50 and older, there is a $1,500 increase to $64,500.
Moving forward to 2021, if you are fortunate enough to be able to max out your retirement contributions, you might consider maxing them out in a way that has a minimal effect on your monthly cash flow by spacing out your contributions evenly over 12 months. If you have an employee-sponsored retirement account available to you, you can ask your HR department to split your contribution over twelve months. If you’re able to contribute the maximum amount of $19,500, that comes out to a $1,625 pre-tax contribution each month.
I understand that most of us are not quite there, but it may be a personal goal you set for yourself in 2021.
Saving for your retirement while reducing your taxable income is a great way to end 2020—or an equally great way to start the new year. Reduce your taxable income by giving money to your future self—and you don’t even need a DeLorean!
References
All retrieved from IRS.gov