There’s a simple reason why people are advised to accumulate savings for retirement. Once you quit your full-time job, you’ll need more than your Social Security checks to cover your living expenses.
If you’ve had an average income during your career, you can expect your Social Security benefits to replace about 40% of your pre-retirement salary. But that’s not much to live on. It is therefore a good idea to regularly build up a portfolio of assets that you can use to supplement these benefits.
In this regard, a 401(k) plan can be a great starting point, if you have access to one. Many of the sponsoring employers also match worker contributions to some degree, increasing the value of your contributions. Plus, annual contribution limits for 401(k)s are much higher than IRA limits, so you can use them to save more and get more of the tax benefits they offer.
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In fact, 401(k) contribution limits increase significantly in 2023 due to high inflation. But should you maximize yours? Not necessarily.
Greater opportunity to fund your retirement nest egg
In 2022, 401(k) plan contributions will cap at $20,500 for those under 50 and $27,000 for those 50 and older. This higher limit for older savers is due to the “catch-up contributions” of up to $6,500 per year they are allowed to make. (And to be clear, you don’t need to be “behind” on your retirement savings to make these catch-up contributions — you just need to be 50.)
In 2023, workers under age 50 will be able to contribute a total of $22,500 to a 401(k). This is an increase of almost 10%. During this time, the catch-up contribution limit will increase from $6,500 to $7,500. So all told, workers 50 and older will have the ability to put up to $30,000 into a 401(k) next year.
Should you maximize your 401(k)?
If your employer is offering to match a certain percentage of your 401(k) contributions, then it pays to invest at least as much money as is needed to recoup all of those matching funds. But beyond that, there are reasons why you might want to find a different vehicle for some of your retirement money.
A disadvantage of 401(k)s is that they tend to limit your investment choices. In many cases, rather than allowing you to buy individual stocks, you will only be allowed to choose from a fairly limited menu of mutual funds and exchange-traded funds.
But these fund choices may not match your risk tolerance or goals. Some can also carry exorbitant fees that will eat away at your returns. (Although it should be noted that 401(k)s generally offer some options for investing in index funds, the fees for which tend to be much more reasonable.)
That’s why you shouldn’t necessarily plan to max out your 401(k) in 2023. A better bet might be to split your retirement investments between a 401(k) and an IRA. This last option gives you a lot more flexibility in how you can invest your money.
The fact that the IRS has given a boost to 401(k) contribution limits for next year is a good thing. But that doesn’t mean that taking full advantage of this higher cap will be the right decision for you. Ultimately, you’ll want to take a close look at the investment options your 401(k) offers before deciding if this account is where you’ll want to put all of your retirement savings in 2023.
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