59% of Americans have access to a 401k account, but only 32% are currently investing in one. If you knew how these retirement plans work and how they can help you build your wealth, would you invest in one? Would you try to meet your 401k contribution limits each year?
If you answered no, is the reason because you don’t have the extra cash to invest in the account? That’s one big reason why a lot of workers don’t contribute to the account. They understand its value, but they simply don’t have the money left over at the end of each month or year to put into the account.
Now, if you find yourself considering a 401k as a way to invest and compound your money, read this guide. It’s essential to understand what the 401k contribution limits are in 2021 so that you can plan ahead. Let’s start with the basics, though.
What is a 401k?
Let's start by defining what a 401k is.
It’s a type of retirement account that allows company employees to save and invest in their own tax-deferred retirement. That’s the technical definition, anyway. In simple terms, it’s an account where you put money that you can’t touch until you retire. The best part about a 401k is that you don’t pay taxes on the money until you withdraw it (depending on the type of account).
- When you withdraw from a traditional 401k during retirement, you’ll be taxed at your most current income tax rate.
- Roth 401k withdrawals aren’t taxable as long as the account is at least five years old and you’re 59½ or older.
- Employer matching contributions to a Roth 401k are subject to income tax, though.
What’s the summary? A 401k account is a tax-advantaged alternative to other retirement accounts. Because they’re tax-advantaged, it means that there’s a cap on how much you can put into the account, though. This is to prevent the rich (mostly) from putting all of their money into a 401k to avoid paying taxes altogether.
What Are the 401k Contributions for 2021?
So, what are those limits? For you as an employee, you can contribute up to $19,500 per year if you’re under 50 and $26,000 if you’re over 50.
Keep in mind that your employer can also contribute to your account! Depending on their offer, they might even provide you with a 50% or 100% match to whatever you’re putting into the account. This is where you can start to earn some serious cash.
If your employer is contributing (or if you want to make additional non-deductible after-tax contributions), that contribution limit goes up to $58,000 or 100% of your salary (whichever is less). If you’re over 50, that limit is $64,500.
How Much Should You Save for Retirement in a 401(k)?
The answer to this depends on how much you can save (which, again, WealthStack can help you with). If you wanna do it big, though, we suggest saving at least 15% of your income for retirement each year. This includes your employer contribution match, though! So if your employer is willing to contribute 5%, then you’ll only have to cover the other 10%.
Not able to save the entire 15%? Try working towards saving 2-3% now and then increase that amount each year. If you’re saving 3% this year, next year you’ll be saving $5, then 7%, and so on. It’s a slow and steady way to build your wealth without putting much pressure on yourself.
How Do 401k Plans Work?
There are two basic types of 401k accounts: traditional 401k and Roth 401k. The only main difference is the way in which they’re taxed. Usually, when you start a new job and are given the option of opening a 401k, you’ll likely be able to choose between the two.
With a traditional 401k, the contributions you’re making are pre-tax dollars, so you get a tax break upfront and don’t have to pay taxes on that money right away. With a Roth 401k, it's basically the opposite.
Is a 401k Plan Worth It?
We suggest taking a lot at our article on How Retirement Accounts Help You Build Wealth to answer this question. In short, 401k plans are totally worth it. But if you’re short on time, take a look at our breakdown of how a 401k helps you save more for retirement.
Let’s say that your employer offers you a 50% match at a maximum of 6% of your salary. This means that if you earn $40,000 a year, their absolute maximum contribution would be $2,400.
But, let’s say that you, too, want to contribute just 6%. You’d be putting $2,400 away into your retirement account. Assuming still that your employer is offering a 50% match, it means that they’ll add $1,200 into your account too! You’ve just earned $1,200 of practically free cash.
However, this all depends on your 401k options and your current financial situation. If your employer offers a generous matching contribution program, you’ll want to take advantage of that. If they don’t and you’re already struggling to make ends meet, don’t beat yourself up about not putting money into the account.
If you fall into the latter category and can’t seem to understand why you never have money left over at the end of each month for basic bills, let alone investing, WealthStack is the place for you.
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