For 2020, 401(k) limits are going up by $500. This means that you can save $19,500 next year, instead of the $19,000 in 2019. Catch up contributions for those over 50 are going up by $500 to are rising to $6,500. So people over 50 can save $26,000 in their 401(k) accounts.
These amounts don’t include employer matches. Defined contribution limit from all sources (employer + employee) is $57,000 for 2020. If you are 50 or older, the maximum defined contribution limit is $63,500.
When creating the retirement plan system, Congress included tax benefits as an incentive for employers to put plans in place and for employees. The goal was to offer retirement benefits to a broader group of employees and not just the higher paid individuals. To achieve this objective, Congress established a series of nondiscrimination tests that retirement plans must satisfy each year in order to preserve their tax benefits.
These nondiscrimination tests ensure that the average benefits provided to two groups of employees—highly compensated employees (referred to as HCEs) and key employees—and compare them to the average benefits provided to the non-HCEs or non-key employees.
A Key Employee is a person who met the following conditions in the prior plan year:
- An officer of the company earning $180,000 or more annually;
- A 1% owner with a salary of $150,000 or more; and,
- A 5% (or more) owner regardless of salary.
A Highly-Compensated is a person who met the following conditions in the prior plan year:
- An officer in the prior year;
- A 5% (or greater) shareholder in the current or prior year;
- An employee paid $125,000 or more in the prior year; and,
- An employee whose salary is in the top 20% of all employees.
How To Get The Most Out of Your 401(k) Plan
Save Early and Save Often
Time is the secret to compounding money. Your investments grow over time. So invest early, and save as much as possible. It sounds like a cliche but I am surprised by how many young people do not participate in their company’s 401(k) plans.
Contribute At Least Enough To Get Company Match
At least contribute enough to get the company match. If your company matches 4% of your contributions, that is like getting a 100% return on your investment on day 1.
Choose Investments Wisely
Your risk tolerance will change as you grow older. Choose an investment that aligns with your goals and risk tolerance. I take a look at my investments once a year and re-balance my asset mix if necessary. Otherwise, I leave them alone.
Most people make the mistake of changing their portfolio allocation based on market fluctuation and trying to time the market. Your portfolio is like a bar of soap. The more you mess with it, the smaller it gets.
Know Your Costs
Investing in your 401(k) involves costs. Mutual funds have expense ratios, and your plan may have administrative expenses.
Review your expenses periodically. If your mutual fund has an expense ratio of more than 1%, you are likely paying too much.
The larger your company, the lower your administrative costs will be as the company will be able to spread the cost across more employees
Set Up Automatic Escalation of Contributions
Most plans allow you to set an increase in your contribution amount every year. I set up mine to go up by 1% every March since that’s when I get my pay raises. This way, my savings go up automatically every year without me having to do anything.
Avoid taking loans, early withdrawals
When you lose your job or have a cash crunch, taking money from your 401(k) either through loans or early withdrawals may be tempting. Even if you can avoid paying penalties on early withdrawals, in the long run, it’s not worth it.
The money you withdraw will not be compounding for you, and you are likely to end up with a smaller nest egg. Having adequate savings outside of 401(k) in an emergency fund will help you avoid dipping into your 401(k) when you encounter tough times.
Take Advantage of Catch-Up Contributions
You can contribute $6500 more to your 401(k) if you are over 50. Take advantage of this if you fall into that category.