Why High Income Workers Should Be Maxing Out Their 401(k)s in 2017
An employer-sponsored 401(k) plan can be an invaluable tool for creating a comfortable retirement, particularly if your company offers matching contributions. According to the Employee Benefits Research Institute, 78% of workers have access to a 401(k) at work and 85% of employees who are eligible to contribute are doing so. Collectively, 401(k) participants have amassed approximately $4.7 trillion in retirement assets.
Making elective salary deferrals to your 401(k) can prove particularly useful if your paycheck has a few extra zeroes at the end. In 2017, there are two important tax changes that can help high-income workers funnel even more cash into building their nest egg.
What’s New for 2017
In terms of what updates are on the menu for the new year, the Internal Revenue Service (IRS) has increased the annual employer contribution limit to 401(k) plans to $54,000. That’s a jump of $1,000 over last year’s maximum limit.
The limit on employee contribution remains the same, however. The most you can directly contribute to your 401(k) for 2017 is $18,000, with one exception. There’s an additional catch-up contribution of $6,000 allowed for workers age 50 and older.
The other significant change the IRS has made centers on the maximum annual income that employers can consider for matching contributions. This year, that amount rises to $270,000, up from $265,000 for 2016. That’s roughly a 2% increase overall. (See: How 401(k) Matching Works.)
How That Affects Your Savings Outlook
The changes mentioned above may seem relatively small, but they could have a big impact on how much you’re able to save for retirement if you’re at the higher end of the income scale. Here’s an example of how the new guidelines could give your savings a boost.
Let’s say you make $300,000 a year and you plan to contribute the full $18,000 towards your employee contribution. That breaks down to an annual contribution rate of 6%. And let’s say your company matches 100% of contributions, up to the first 6% of your income. (Read: What Is a Good 401(k) Match?)
Under last year’s rules, your employer would only be able to match contributions for $265,000 of your $300,000 salary. For 2017, it can match contributions for $270,000 instead. That increases your employer’s annual contribution by $300 ($270,000 x 0.06 = $16,200 vs. $265,000 x 0.06 = $15,900).
Now, let’s assume that you get that same $300 a year extra in matching contributions over a period of 30 years and your 401(k) earns an average annual return of 7%. That would give you an additional $28,338 to put towards retirement. If your employer offers to match a higher percentage of your salary, that could yield even better results over the long term.
Besides that, there’s another good reason to consider maxing out your plan this year. President Trump has proposed changes to the federal tax brackets which could impact certain middle and higher income workers. Specifically, there would be a move from seven brackets to just three: 12%, 25% and 33%.
The highest tax rate would apply to single filers earning $112,500 per year and married couples earning $225,000 or more. As of 2017, the 33% tax rate applies to single filers earning between $191,650 and $416,700 and married couples with a combined income of $233,350 to $416,700. Trump’s plan would effectively impose a higher tax rate on workers who currently land in the 28% bracket. Deferring more of your salary into your 401(k) could aid in reducing your tax liability if Trump’s proposal becomes a reality. (See: Trump’s Upper-Middle Class Tax Increase.)
The Bottom Line
Beyond these considerations, there’s another good reason to think about contributing as much as possible to your 401(k) or a similar employer-sponsored plan. These plans allow for tax-deferred growth, meaning you won’t owe taxes on earnings until you begin taking distributions in retirement. If you anticipate your income decreasing once you retire, that could result in fewer taxes owed. The takeaway? When it comes to your 401(k), every penny counts.