If you are socking away money each pay period in a 401k, 403(b) or 457 retirement plan, congratulations! This is one of the best things you can do to help prepare for a financially secure retirement.
However, there are limits on how much money you can contribute to these plans each year. These limits, which are also referred to as elective salary deferral limits, are adjusted periodically by the IRS to account for the effects of inflation.
No Inflation Adjustment for 2021
Because of low inflation, the annual contribution limit for 401k, 403(b) and 457 plans will not rise for tax year 2021. It will remain at $19,500 for individuals who are under 50 years of age. The annual contribution limit for SIMPLE 401k plans will also remain the same next year: $13,500 for individuals who are under 50 years of age.
However, special catch-up contributions are allowed for individuals who are 50 years of age or over to help them boost retirement savings as they get closer to their retirement date. In 2021, the catch-up contribution amount for 401k, 403(b) and some governmental 457 plans is $6,500, which brings the total contribution limit up to $26,000 for these individuals. The catch-up contribution amount for a SIMPLE 401k is $3,000, which brings the total contribution limit up to $16,500.
Note that these contribution limits are per person, so a married couple can potentially save twice this much combined by contributing to separate 401k, 403(b) or 457 accounts.
Read More: The Average 401k Balance By Age
Combined Contribution Limit
If your employer makes matching contributions to your account, these amounts don’t count toward the annual employee contribution limits. However, there is an annual limit for combined employee and employer contributions: In 2021, this limit is 100% of compensation or $58,000 ($64,500 for individuals 50 years of age or over), whichever comes first, to 401k, 403(b) and 457 plans.
It’s a good idea to evaluate your estimated contributions for the year ahead now so you don’t over-contribute to your plan. If you do over-contribute, you have until March 1 of the following year to notify the IRS. Excess deferrals should then be returned to you by the following April 15.
The amount of compensation that can be considered when determining combined employer and employee contributions to 401k, 403(b) and 457 in 2021 is $290,000.
Early Withdrawal Penalties
Funds contributed to 401k, 403(b) and certain other employer plans should be earmarked for retirement. To discourage individuals from withdrawing these funds early and potentially jeopardizing their retirement financial security, the IRS imposes penalties for most early withdrawals that are made before age 59 and a half. However, some plans allow participants to make loans from their account balances.
Note that the Coronavirus Aid, Relief, and Economic Security (CARES) Act relaxed some of the restrictions related to early withdrawals from these plans. For tax year 2020, individuals with a valid COVID-19-related reason can withdraw up to $100,000 from their accounts penalty-free, regardless of their age. The CARES Act also increases the limit on how much money can be borrowed from a plan balance and suspends the mandatory 20% tax withholding that normally applies to early withdrawals.
How Financial Technology Can Help
The Personal Capital Retirement Planner can help you design a customized retirement plan that’s right for you. Millions of people use this tool to see if they’re on track for retirement, and what they can do to improve their chances of retirement success. Using this technology, you can:
- Get perspective by seeing how your plan would have fared in historical market events
- Run different scenarios with a side-by-side comparison
- Anticipate big life expenses to see how it impacts your retirement
- Add additional sources of income
- Get a retirement spending plan
The most important part of contributing to your retirement? Having a plan. Make sure yours is right for you.