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%
Source: https://en.wikipedia.org/wiki/S%26P_500
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?
Images courtesy of FreeDigitalPhotos.net
Since I have a solo 401k, I can put in even more. My max this year would have been around $32k, but we did not hit it. I would love, to but that would mean no real estate,529, or general stock investing. I did put in $25k, which was my goal. I think next year, I will for sure do the $18K and see where we are. Self employment taxes are killer, so to minimize that is very important. This new real estate project will probably need some work sooner rather than later, otherwise, I’d shoot for the stars!
$25k is a 1,000% respectable contribution. I don’t blame you for diversifying and spreading out your capital among the other investments. That’s a smart move.
That’s great news to hear for 2015. I need to readjust my 401k percentage to make sure I hit that max. Plus of course get my employer match. Good tips for ways to make it to 18%!
Thanks and good luck raising your contribution percentage. It will be well worth it.
We just recently maxed out our employer contribution and we aren’t really in a position to do more than that. But you know what?? I had NO idea about this change. Awesome article!
I’m glad to spread the word!
I’ve been pretty good about maxing out my ROTH each year, but $5,500 is a lot easier to save than $18k 😉
Maxing out the Roth IRA is a great move. Can you imagine if you were to fully invest in both?
Awesome post! For the last few years every raise I get I put into my 401k. I will be getting a raise in about a month and after putting that in there I will be getting close to the max.
I am a pharmacist and am taxed at a very high rate. The 401k contributions really help with my tax savings so not only am I saving a lot for retirement, I am saving money now on my taxes.
Thanks for pointing out the benefit of your tax savings. I think a lot of high tax bracket / high income earners could benefit more from tax-sheltering now rather than later on when they retire.
May I add one to your list. of reasons to max your 401(k) that I never understood until 2 years ago and caused me to max mine since and will continue until I stop working.
Our tax rate is based on a tiered system. You’re taxed at different rates on your last dollar earned than your first. When you defer paying taxes by contributing into a 401(k), you are paying no taxes on this last money which would be taxed at your top rate (25%, 28% or even 33%). If you spend much less than you earn (which if you are able to max out these accounts you would have to) then when you do pay taxes you can pay only on the much lower amount that you need in a given year. Therefore the money would fall into the lower tax rates. Thus, in addition to keeping more money working for you for a long time as you point out, when you do pay the taxes you can pay a much, much lower rate or with some careful planning, no taxes at all. This means even much more cash in your pocket, and less to the government. This is a difficult concept to explain clearly in a comment. Hope that makes sense!
ChrisEE – I catch what you’re saying. The same sort of logic can also be used to argue why a Traditional 401k or IRA is a better deal than a Roth version of either. Check out my complete breakdown of the situation at this post here.
Yes! I had not seen that post before but the first part about the regular 401(k) vs Roth 401(k) is exactly what I am talking about. I anticipate being in a much lower tax bracket when I draw on these accounts in the future as we are preparing for early retirement based on living a relatively frugal lifestyle. In any event, I would think that if you saved “too much” such that you put yourself into a higher tax bracket in retirement than you were in when working then that probably is not the worst problem in the world to have.
We addressed our thoughts on this issue in this blog post. https://eatthefinancialelephant.com/how-we-increased-our-net-worth-by-8750-this-year-without-earning-more-or-spending-less/
If you have a few minutes, I’d be curious to hear your feedback.
Cheers!
ChrisEE
I will check that out. Thanks!
Maximising retirement accounts over the long term is critical to financial freedom in retirement!
I love the comparison you’ve made, showing the volatility of returns dramatically reduces over the long term.
I’m a huge fan of long term investing and riding out the downturns.
Without time on my side, there’s no way I would hit my $10m retirement goal.
Thanks. I think the average investor can take a lot of comfort in those historical trends. Without knowing anything about stocks or investing it just goes to show you that the average trend naturally gravitates upward over time. Virtually anyone can get on board this good thing. They just have to recognize it first and get over their own fear.
I love the data on returns over different periods. Can you point us to where you got that data? I would be great to see more breakdowns, and perhaps the mean or median returns for those periods.
Please see in the content to just below the data there is a link to Wikipedia.
Doing some hustles does help us save more for 410k. I have two extra jobs, the money I get from these goes directly to my emergency and 401k savings. For the last three years, my Christmas bonus have been saved for my 401k. You may try it. My friends were shocked when I told them that I was able to do so with no regrets.
Nice work stashing away your bonus for the last 3 years! That’s great.
Good advice on using your extra income to offset your other goals. I’ve got a similar thing going on myself. My income from blogging helps me to defer more of our employment income into our 401k, 403b, and IRA funds. I keep trying to figure out how I take this to the next level by re-organizing our budget so that I can start saving more of my blog income as well.
Great tips…We are currently maxing out on our Roth IRA but unfortunately have to admit that we don’t max out on our 457K. We do try to consistently have a side hustle to help generate extra funds for retirement and/or investing. And definitely, we always put most our windfalls towards our future! AFFJ
That’s great to hear your side hustles are going towards your savings goals. Every little bit helps!
My 401k option has super high fees and no employer match, plus I’m in a pretty low tax bracket (thanks, kids!) so an IRA has been the best option for us.
This is exciting that they upped the limits, though! If I had an employer match/lower fees, I’d be pretty psyched about those contribution limits.
High fees and no match? I’d agree that maxing out the IRA first before doing anything with the 401k is probably the better move.
I’m sure that in the next 1-2 years they will likely increase the IRA contribution limits. They usually don’t stay put for very long.
I’m looking for 2015 to be the first year I max out my 401K, have some student loan debt to clear up and then it’s on like Donkey Kong!
Nice work! Keep your eyes on the prize.