If you’re one of those people who are really good at saving their money diligently for retirement, then the IRS has some good news for you next year: The 2015 maximum 401k contribution has just been increased to $18,000 (up $500 from 2014).
For those people 50 and older, the $5,500 catch-up limit was also bumped up to $6,000.
I’ve personally been saving up to the 401k maximum for a while now and am looking forward to bumping up my contributions. By saving so much I know that I’m not only helping my family to get closer to reaching financial freedom, but we’re also taking advantage of a few other extremely important benefits. Here are what they are and what you can do to help yourself get that point too.
Why Max Out or Save Your Money In a 401k at All?
401k plans are wonderful saving tools for individuals because they give you the power to invest in the stock market, grow your money tax-free, and control your own retirement destiny.
Though it may seem impossible for some people, when asked I always tell people to try to save as close to the 401k contribution upper limit as possible (read my detailed explanation why here). To quickly summarize:
- You get to save more of your money because you’re doing so tax-free.
- Starting early allows compound interest to go wild growing your money to sums far beyond anything you could ever save on your own.
Even though those are some very solid reasons, there’s another really important motive for why you should be saving your money in the stock market for the long-haul:
By doing so you take the opportunity to reduce your risk of loss and capture some pretty outstanding returns.
If you don’t think so, just have a look for yourself.
Saving Long-Term Minimizes Losses:
Consider the S&P 500 stock market index – a simple index fund made up of the top 500 companies.
True – stocks are a risky short term investment. If you had invested your money for a single year any time between 1970 and 2013, you could have seen gains as high as 37.58% or a loss as low as −37.00%.
But now what if you had invested your money for 5 years during those times? You would have seen an annualized return as high as 28.56% or a loss as low as −2.35%.
Now notice what happens as the amount of time you invest your money increases:
- 10 years: Highest return 19.21%, Lowest return −1.38%
- 15 years: Highest return 18.93%, Lowest return 4.47%
- 20 years: Highest return 17.88%, Lowest return 7.81%
- 25 years: Highest return 17.25%, Lowest return 9.28%
The takeaway: The more time you give yourself to invest in the market, the better your chances are of having a positive net return on your money.
Seriously – what other investments are willing to pay you somewhere between 9.28% and 17.25% every year for the next 25 years? Could you imagine maxing out your 401k for 25 years or more and seeing an average 17.25% return every year? Not only would you reach your retirement goals, but you probably would have exceeded them as well!
What Can You Do to Maximize your 401k?
Like I said before – I understand that $18,000 may sound like a lot. But it’s not out of the question that you could one day reach that upper 401k limit.
Here are a few things you can try to increase your own 401k contributions:
- Examine your budget and take a really hard look. What are you spending your money on? Do you really need everything you’re buying? Are the things you’re buying really as important as reaching your retirement goals? Be tough on yourself.
- Defer your raise. If you’re one of those lucky people who receive a raise every year, then why not take the extra money you’re going to receive and move that directly into your retirement plan? You were probably fine living off of whatever you earned last year, and chances are that the extra money you’ll be earning won’t get put to use on anything that would have the same long-term earning potential as your 401k funds. Even if you take at least half of your raise and apply it towards your 401k, that would be better than doing nothing at all.
- Free up some money with other tax-advantaged accounts. If you’ve never heard of a flexible spending account (FSA) or health saving account (HAS), then chances are you’re paying too much for your children’s daycare or family medical expenses. Most employers will allow you to use these types of accounts to sanction money pre-tax and cover these types of expenses. By doing so, that should leave extra money in your budget to re-route back into your 401k.
- Bank those windfalls. Are you expecting an income tax return? Bonus? Profit-sharing? Inheritance? If so why not use these large sums of money to cover your living expenses while you devote more of your paycheck to your retirement savings efforts.
- Make some extra money on the side. It doesn’t matter whether you take online surveys for cash or create money earning websites like I do – everyone has something they can be doing on the side that will help produce some extra income outside of your job. And of course by doing, you can use this money for your living expenses while contributing more to your 401k.
- Not save so much in taxable accounts. It’s great to have an emergency fund savings account or even a regular brokerage account. But saving your money in these places won’t give you the same tax-advantaged investment growth that a 401k will. Consider how much of your money you truly need to be liquid and perhaps defer a portion of that savings into your retirement account instead.
If you’d like to see how much your 401k will be worth over time if you were to add more contributions, free software like Personal Capital can help you by easily importing your balance and letting you play with the variables to see what might happen.
Readers – Who will be trying to hit the new 2015 maximum 401k contribution next year? Do you have any other strategies to help other get there?
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