401(k) can be an adequate way to increase your retirement funds. While the plan is undoubtedly a popular and preferred tool of savings, its contribution limit often presents certain challenges. This is because the government changes the rules and limits of how much one can pay towards a 401(k) plan every year, and 2020 is not different.

As announced by the IRS authorities, the contribution limit is set to increase from $19,000 to $19,500 in 2020. More information can be explored on their official website but here’s a quick look at some key changes you must know:

Major highlights

• Retaining the trend of a $500 annual increase, this year will foresee the capped limit climb up to $19,500 from $16,500 in 2009.
• The amount has come a long way pertaining to the rate of inflation. Along with the limit, the catch-up contribution this year will increase from $6,000 to $6,500 and the maximum allocation will be $57,000 as compared to last year’s $56,000.
• The maximum allocation is calculated based on the allowable catch-up contribution for workers over 50 years of age.
• The contribution limit applies to workers who are participating in a 401(k) plan, 457 plans and 403(b) plans. Individuals claiming the Thrift Savings plan will also enjoy the same increased limits.
• Retirees having SIMPLE (Savings Incentive Match Plan for Employees) accounts will also relish the increased limits from 13,000 to 13,500.
• The amount of income required for contributions to IRAs and Roth IRAs for claiming the Saver Credit are also increased in the year 2020.

Phasing out conditions

If the beneficiary of 401 (k) accounts is taking a retirement plan during work, the deductions will be phased out or decreased. This will depend on the following conditions:

• The deduction will be phased out for an IRA beneficiary who is not covered by the retirement plan of the workplace but is married to someone who is covered under the plan. This used to earlier apply to an income between $ 196,000 and $ 206,000. The limit has now increased to $193,000 and $203,000.
• The phase-out range has changed from $65,000 – $75,000 to $64,000 – $74,000 for a taxpayer who is covered by the retirement plan of the employer.
• For couples who decide to file jointly, the phase-out range will be changed from $104,000 -$124,000 to $103,000 -$123,000. This is applicable if one partner makes the IRA contribution covered by the employer retirement plan.
• For an individual who is filing the IRA return and covered by the retirement plan of the company he or she is working in, the phasing out range will not depend on the annual cost-of-living adjustment. The limit remains unchanged and is capped from $0 to $10,000.

Changes to Roth 401 (k) contributions

The major changes remain the same for the contribution limits for Roth IRA as they are for the traditional 401 (k) plan, with the limit extended to $19,500 in this case as well. Many individuals might look forward to contributing towards both Roth 401 (k) and traditional 401 (k) by allocating equal amounts from the total sum of $19,500.

You must also take note that the contributions limits of the 401 (k) plan are the same as that of the Thrift Savings plan and the 403 (b) plan. Also, the employer matching contributions can be made up to a limit that exceeds the given value of $19,500. This can even surpass the combined value of $26,000. The only condition is that the beneficiary should be above 50. This signifies that you can make large contributions without any worries towards one or both Roth 401 (k) and Roth IRA accounts.

Considering the maximum allocation limit

This year’s maximum allocation limit i.e. $57,000 is the total sum of money you are allowed to contribute towards any type of tax-savings retirement plan. It is important to note that many individuals fail to reach this maximum allocation limit, failing to take full advantage of the 401 (k) contributions. The increased amount in 2020 may foresee people above 50 using considerate plans pertaining to this limit. For workers above 50, they can contribute even beyond the 401 (k) plan to try to reach the limit set by the government this year i.e. $63,000. The maximum allocation perimeter also allows you to make tax-sheltered contributions to a normal IRA and gives you the liberty to make tax-saving Roth IRA contributions. This applies if the income is within the limits of the plan you are bearing in mind.

The takeaway

The change in contribution limit for a 401 (k) plan isn’t the real deal with employees. The main problem is the lack of participation. Many employees overlook participating in the 401 (k) plan and ignore its long-term benefits. While many deny contributing on a regular basis, others simply fail to realize that their workplace is offering such a plan. With this year’s increased limit, many workers might start showing interest in this efficient tax-saving retirement plan.

The average amount of contribution in the 401(k) plan was $103,700 in 2018. Around 50% of employees succeeded in maintaining this value while the other 50% failed to do so. Statistics also show that workers below 50 years were able to reach just $42,400 contributions in their accounts. This indicates that only a small percentage of income is earned by the employees through this plan, revealing that contribution limits are never inadequate.

To sum it up

401(k) plans were introduced by the government with a simple, fair aim to boost the retirement savings of a worker. This purpose remains intact till today and an increased contribution limit makes it easier for people to reach their retirement goals sooner.  The plan still has a lot of tax-savings potential. Nevertheless, it remains as one of the most effective tool of retirement savings.

Are you unsure of how the changes in the contribution limit of the 401(k) plan affect you? Reach out to financial advisors to know more about any new amendments and changes in the plan.