IRS raises 2023 retirement savings cap, but few even hit it. Here's what you can do about it.
- The IRS is allowing people to add more to their retirement accounts next year to grow tax free.
- Most people don't ever hit those limits, losing both tax benefits and earnings growth.
- That can change if people take budgeting and savings steps to take advantage of this benefit.
Most of the news on inflation has been bad, but retirement savers may have been given a silver lining – if they’re savers and if they can afford to take advantage of it.
The IRS lifted last year by a record amount the cap on how much people can sock away in retirement accounts on a tax-deferred basis, mostly because of soaring inflation.
But here's the rub: Only 14% of employees who participate in company retirement plans contributed last year to IRS limits, according to Vanguard.
Add four-decade-high inflation, and 54% of the 1,000 Americans Allianz Life surveyed in September said they've have stopped or reduced retirement savings.
And that's even as people’s expectations rise for how much they need to retire comfortably ($1.25 million now, according to a recent Northwestern Mutual survey, up 20% from last year), people are saving less.
“I think what’s going to happen is those putting away the maximum right now will take advantage of the new caps, but that’s just a small portion of people who contribute to retirement plans,” said Kelly LaVigne, consumer insights vice president at Allianz Life.
But that doesn't have to be the case if people follow budgeting and savings steps, they, too, can move toward tax-free earnings growth.
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What are the 2023 401(k) limits?
In 2023, employees participating in company retirement plans can contribute $22,500 to their 401(k), up $2,000 from this year. Those who don’t participate in an employe-sponsored plan will be able to contribute $6,500, up from $6,000, to an individual retirement account (IRA).
Additionally, the catch-up contribution limit for employees ages 50 and older is increasing to $7,500 in 2023, up from $6,500 in 2022. That means those participants will be able to contribute up to $30,000 total. The IRA catch‑up contribution limit, though, will remain at $1,000, the IRS said.
What’s a 401(k) and an IRA, and what’s the difference?
A 401(k) is a retirement savings plan offered by companies to employees. Many firms also match, meaning they’ll contribute the same amount you do to your retirement, usually up to a certain amount. Only your contributions count toward the IRS cap, so matching can boost your total savings over the IRS cap and is what advisers call “free money.” So at least contribute enough to get the full match, if you can, advisers say.
Contributions are taken from your paycheck before taxes, so that also lowers your taxable income. You pay taxes only on withdrawals, so your money grows tax-free while it’s in your 401(k).
IRAs are opened by individuals through a brokerage or bank. Depending on your income and filing status, all or part of your contributions may be fully or partially deductible, making this investment tax-advantaged too. Only withdrawals are taxed.
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How do people feel about retirement?
Nervous, but still not saving properly.
Last year, nearly 70% of people surveyed by Invesco said they’re afraid of running out of money in retirement.
Americans' average retirement savings has dropped 11% to $86,869 from $98,800 last year, while their expected retirement age has risen to 64 years from 62.6 last year, the survey said.
Why aren’t people saving more for retirement?
There are many reasons.
“People like to live in the moment, and retirement is too far away for many to think about and plan for,” said Brian Snow, who invests and saves with his investment club BetterInvesting.
Many consumers must divert the money elsewhere, thanks to inflation, which “has outpaced the growth in average hourly earnings and squeezed household budgets, and a limited capacity to increase retirement savings is a byproduct of that," said Greg McBride, Bankrate chief financial analyst.
Others lack the financial know-how or discipline.
Salary isn’t "the only factor in why folks don't max out the 401(k),” said saver Byron Williams. “It’s not a matter of how much one makes but rather what one does with what they make.”
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How do you start saving?
Start with a budget, advises Akari Muhisani, who credits a 2008 'Jesus moment' with jump-starting his savings plan.
“I had $25,000 in credit card debt and didn’t want to be broke and live paycheck to paycheck like my mother,” Muhisani said.
He started applying extra money to his debt, smallest balance first. In two years, Muhisani paid off his credit card balances.
After that, he began saving, setting aside 10% of his income for his future. He now has emergency savings of about three to six months of living expenses and retirement savings. If he has money left at the end of the month, he adds more to savings or to max out his 401(k).
Williams contributes a percentage of his annual raises to his 401(k).
“Some years, I took the entire raise and put it in the 401(k), forcing me to live off the same salary I lived off the year before,” he said. “It is not rocket science, but rather based on knowing the power of maxing out a 401(k) and having the discipline to do it.”
Some advisers suggest investing your tax refund, too.
How do you grow your savings?
Invest it – early.
“Too many people delay and do not invest early,” Snow said.
Early is key for compounding, which means earnings on your savings are reinvested to generate their own earnings, allowing for exponential growth.
If you can’t save the recommended 12% to 15% of your annual income, then “save at the level you can,” said Matt Fleming, wealth adviser at Vanguard Personal Advisor Services. “Later, step up contributions by 1%-3% per year to meet your target.”
And it’s better to automate savings so they’re deducted monthly from your paycheck or bank account into your 401(k) plan or other retirement fund.
You'll put your money to work as you earn it, buying you more time for compound growth.
But how do you invest it?
Investing can be daunting with so many numbers, options and tax consequences. Some people turn to financial advisers. Muhisani joined an investment club.
“Investment clubs are great for meeting everyday people, retirees who do this – man, they’re so smart, and they never studied this before,” he said, noting the Beardstown Ladies club inspired him. "They’re regular ladies that invest in the market and are always on the top of CNBC’s investment challenge.”
There, he says, he learned about company financial statements, valuations, funds, fees, retirement funds and more and has parlayed his savings into about $1 million in total retirement money.
Education would be the first step, Williams said. “Ensuring that folks really understand the 401(k), its benefits and how to leverage it is key.”
Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at firstname.lastname@example.org and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.