There is no time like the present to increase your retirement plan contributions, but those who commit more of their hard-earned salary to their retirement nest egg must be mindful of the IRS limit.
Indeed, the federal government places limits on the dollar amount individuals may contribute to tax favored accounts each year, including Individual Retirement Accounts and 401(k)s, which adjust annually to reflect cost-of-living increases.
For 2016, the retirement plan contribution limit for 401(k), 457 and 403(b) plans is $18,000. If you are age 50 or older by the end of the calendar year, you may be eligible to make additional catch-up contributions of up to $6,000, bringing the total you may contribute on a pre-tax basis for the current tax year to $24,000.
The maximum yearly contribution to traditional and Roth IRAs is $5,500. In 2016, those 50 and older can contribute an additional $1,000 to their traditional or Roth IRA, as well. In the case of a Roth, you may not be eligible to contribute that much, however, depending on your income or your filing status.
An additional “catch up” provision exists for state and local government employees, and some nonprofit workers who are eligible for a 457(b) plan. Also, the 457(b) plan has to specifically allow the catch-up contribution in its terms. The special 457(b) pre-retirement catch-up is available during the three years prior to, but not including, the year in which plan participants will reach normal retirement age. In 2016, those who qualify can contribute either twice the annual limit ($36,000) or the basic annual limit plus the amount of the basic limit not used in prior years – whichever is less. That option is only available, however, if the plan participant is not already taking advantage of the standard age 50 and older catch-up contribution; it is one or the other, not both.
Thus, if your normal retirement age is 65, you would only be able to make 457(b) pre-retirement contributions during the years in which you were 64, 63, and 62. But in the years between ages 50 and 61, you have the option to take advantage of making the 50-years-or-older catch-up contributions.
If you do not plan to make 457(b) pre-retirement contributions, you can instead make 50-years-or-older catch-up contributions from age 50 until the year you retire.
A similar catch-up provision exists for 403(b) plans. If permitted by their plan, employees who are 50 or older at the end of the calendar year may contribute an additional $6,000 in 2016 beyond the basic limit on elective deferrals.
Even a minor increase to your retirement account contribution can yield big returns for your long term financial security.
A 30-year-old making $60,000 a year with nothing yet saved for retirement would accumulate $917,749 by age 65 if she contributed 5 percent of her salary to her retirement plan. That assumes a 3 percent raise per year, a hypothetical 7 percent annual investment return, and 50 percent employer match, up to 6 percent of her salary.
If she instead contributed 10 percent of her salary each year with the same assumptions, her retirement savings account would total $1,590,768, according to the AARP 401(k) calculator.
“Most people are going to fall well short of their savings goal, so you should always save as much as you can, but at least enough to get the employer match,” said Matt Rutledge, a research economist at the Center for Retirement Research at Boston College. “You don’t want to leave money on the table.”
Many financial professionals recommend retirement savers sock away between 10 percent and 15 percent of their income annually. But that is merely a guideline.
It all depends on the age you start saving, said Rutledge.
“If you start saving early, at around age 20, you can afford to save 10 percent of your salary, but if you wait until age 30 to start saving you will need to increase your contribution to 15 percent or more because you will have lost some of the power of compounded growth,” he said. “The earlier you start saving, the easier it is to hit your goals.”
Those percentage targets include the employer match, “so it may be a little easier than you think” to save a sufficient amount, said Rutledge.
To estimate how much money you will need to retire comfortably, project your future expenses and calculate your guaranteed sources of income from Social Security, annuities and any pensions you may have. (Calculator: What Will My Monthly Retirement Income Be?)
The difference is what you will need to generate from personal savings and investments to fund your monthly living expenses.
A 4 percent withdrawal rate from your nest egg, adjusted annually for inflation, is generally considered a safe target to ensure you don’t outlive your retirement savings.
But once again, retirement planning is not one-size-fits-all. You may be able to withdraw more (or less) depending on the amount you have saved, your life expectancy, the return on your investments, and your monthly living expenses.
You may also be able to mitigate the risk of outliving your retirement accounts by purchasing a deferred income annuity, which can act as longevity insurance, said Rutledge.
Such products provide guaranteed income for life starting at a point in the future.
Deferred income annuities “make a lot of sense for a lot of people, because you don’t have to worry so much about whether a 4 percent withdrawal rate is right,” said Rutledge. “You can spend your savings a little more freely, because you know that you only need to make your money last until the (annuity) kicks in.”
More from MassMutual…Beyond the Basics: Other Retirement Savings Techniques