A 401(k) account provides valuable benefits to retirement savers. Contributing to a 401(k) plan allows you to qualify for tax breaks and employer contributions. There is also an opportunity to set up automatic savings and the potential for investment growth. But you also need to avoid 401(k) fees and penalties to make the most of your account.
Here’s how to maximize the value of your 401(k) account in 2023.
— Qualify for tax breaks.
— Make catch-up contributions.
— Reset your automatic contributions.
— Get a 401(k) match.
— Consider a Roth 401(k).
— Select low-cost funds.
— Avoid penalties.
— Sign up for direct deposit.
— Increase your withholding.
— Don’t stick with the default savings rate.
[Related:What Will the Social Security COLA Raise Be for 2024?]
Qualify for Tax Breaks
You can defer paying income tax on up to $22,500 that you save in a 401(k) plan in 2023. A worker paying a 24% tax rate who saves this amount could reduce their tax bill by $5,400. Income tax won’t be due on this money until it is withdrawn from the account. Workers who earn less than $36,500 in 2023 ($73,000 for couples) might additionally qualify for the saver’s credit, which is worth between 10% and 50% of 401(k) contributions up to $2,000 for individuals and $4,000 for couples. The biggest saver’s credits go to workers with the lowest incomes.
Make Catch-Up Contributions
Employees age 50 and older are eligible to make catch-up contributions to 401(k) plans. The 401(k) catch-up contribution limit is $7,500 in 2023. Older workers can defer paying income tax on up to $30,000 in a 401(k) account. A 55-year-old employee paying 24% in taxes who maxes out his 401(k) plan could reduce his current tax bill by $7,200. You can defer paying income tax on your catch-up contributions until you withdraw the money from the account.
“Analyze your current financial situation and create a budget that allows you to allocate enough funds to max out your 401(k),” says Cameron Burskey, senior partner and managing director at Cornerstone Financial Services in Southfield, Michigan. “Review your income, expenses and savings to determine how much you can comfortably contribute each paycheck.”
Reset Your Automatic Contributions
Most 401(k) contributions are automatically withheld from your paycheck and deposited in a retirement account. The 401(k) contribution limit increased by $2,000 in 2023, so take care to adjust the withholding from your paychecks. Those who want to max out their 401(k) in 2023 need to save about $1,875 per month or $937.50 per twice-monthly paycheck. Workers age 50 and older can defer paying income tax on as much as $2,500 per month.
[Related:How to Retire on $500K]
Get a 401(k) Match
If you can’t max out your 401(k), aim to save at least enough to get a 401(k) match. A 401(k) match of 50 cents for each dollar you save in the 401(k) plan up to 6% of pay is a 50% return on your investment. A dollar-for-dollar 401(k) match doubles your money. “It’s essentially free money that boosts your retirement savings,” Burskey says. You need to be vested in the 401(k) plan to keep your employer’s contributions to the plan, which might require several years on the job.
Consider a Roth 401(k)
While traditional 401(k) plans allow you to defer paying income tax on your retirement savings, some employers additionally provide an after-tax Roth 401(k) option. “Pretax contributions will reduce your income now, so it is often better to do this during your high-income earning years,” says Jamieson Hopp, a financial planner at Millennial Wealth in Seattle.
Your withdrawals will be taxed later in retirement. “The opposite is true when it comes to Roth contributions,” Hopp says. “Your contributions do not reduce your current earnings, but you will enjoy tax-free withdrawals upon distribution in retirement.”
Select Low-Cost Funds
Regardless of how your investments perform, 401(k) fees are deducted from your returns. Your plan sponsor is required to send you a 401(k) fee disclosure statement that lists how much each fund in your 401(k) plan costs to own. Find out if your 401(k) plan provides a lower-cost fund that meets your investment needs. Selecting low-cost funds can help your retirement savings compound faster.
Avoid Penalties
Pay close attention to your age when deciding when to start 401(k) withdrawals. There are penalties if you take money out of your 401(k) account too soon or too late. You will typically be charged a 10% early withdrawal penalty if you initiate a 401(k) distribution before age 59 1/2. You could face a 25% penalty if you fail to take a required minimum distribution from your 401(k) plan and pay the resulting income tax bill, each year after age 72 (or 73 if you reach age 72 after Dec. 31, 2022). The charge may only be 10% if the required minimum distribution is corrected within two years.
Sign Up for Direct Deposit
Contributions to your 401(k) plan are typically withheld from your paycheck before you ever get a chance to spend the money. You might be asked to select a percentage of your salary to contribute to the 401(k) plan. A 40-year-old worker earning $100,000 would need to contribute 22.5% of pay to a 401(k) plan to max out the account in 2023. However, if you select a savings percentage that allows you to max out your account and then get a mid-year raise, you may need to decrease your savings rate to avoid exceeding the 401(k) annual contribution limit.
Increase Your Withholding
If you’re on a tight budget, aim to increase your savings rate when you can. “If you are eligible for a bonus, you can direct some or all of the bonus to go right to your 401(k),” says Eric Mangold, a wealth manager at Argosy Wealth Management in New York City. “You simply need to inform your human resources or payroll department of your intention so that they can make that contribution for you.” Some 401(k) plans have an automatic escalation feature that will increase your savings rate over time without any further action.
[Read: 401(k) Mistakes to Avoid.]
Don’t Stick With the Default Savings Rate
Many employees are automatically enrolled in their workplace 401(k) plan. When this happens, the default savings rate is typically 6% of pay. Many financial advisors recommend saving more than 10% of your income for retirement.
Should You Max Out Your 401(k)?
Fully funding your 401(k) plan is a worthy financial goal that can also help you save money on taxes. However, there are some circumstances when it can make sense to tackle more immediate financial obligations first, such as creating an emergency fund or paying down high-interest debt. “If you are just starting to save and you know you cannot maximize your contributions in a 401(k), then making sure you at least save up to your employer match is always a good goal,” Hopp says. “Once you have figured out where and what you can save, you can start reaping the rewards of your 401(k).”
More from U.S. News
What You Need to Know About a Safe Harbor 401(k)
Are 401(k)s Protected in a Bank Collapse?
Factors to Consider Before Cashing Out a 401(k)
How to Max Out Your 401(k) in 2023 originally appeared on usnews.com
Update 08/11/23: This story was published at an earlier date and has been updated with new information.
