The maximum annual contribution limit for 401(k) plans in 2023 is set at $22,500. That goes up to $30,000 if you’re over 50 years old. A 401k rollover is not included in that number. Neither are any contributions made by your employer. The IRS only sets a limit on how much you can contribute. “Maxing out” your 401(k) means you contribute the full amount.
Why does the IRS have a maximum contribution limit?
The IRS instituted contribution limits on retirement plans to level the playing field between high-income employees and those who are not as fortunate. The limitations restrict the amount of money you can defer paying taxes on and prevent you from taking unfair advantage of the progressive tax bracket system. The chart below shows how that system works in 2023:
| Tax Bracket | Individual Income | Married Filing Jointly Income |
| 10% | $11,000 or less | $22,000 or less |
| 12% | $11,001 to $44,725 | $22,001 to $89,450 |
| 22% | $44,726 to $$95,375 | $89,451 to $190,750 |
| 24% | $95,376 to $182,100 | $190,751 to $364,200 |
| 32% | $182,101 to $231,250 | $364,201 to $462,500 |
| 35% | $231,251 to $578,125 | $462,501 to $693,750 |
| 37% | $578,126 or more | $693,751 or more |
5 benefits to maxing out your 401(k) plan
Contributing the maximum amount allowed by the IRS into your 401(k) plan each year can be beneficial in several ways. The most obvious is that you’ll build your retirement savings faster. That and other benefits are explained in the list below.
1.401(k) contributions lower your taxable income
Your pay stub lists all the deductions from your check each pay period. You’ll notice that 401(k) contributions come out before your federal or state tax withholdings. That’s intentional. 401(k) contributions are tax-deferred, lowering the income you will need to pay taxes on this year. Income tax on that money is paid when you withdraw it.
2.Lower taxable income could lower your tax bracket
The United States uses a progressive tax system. The more you make, the higher the percentage of your income you’ll pay in taxes. Lowering your taxable income could put you in a lower tax bracket. For instance, if you’re making $100,000 per year and you contribute $22,500 of that to your 401(k), your tax bracket will go from 24% to 22%. (See Chart Above)
3.Higher 401(k) balances lead to better compounded returns
Investment returns and interest payments compound over time if you leave them in the account. Higher balances produce higher returns that compound daily, monthly, or annually inside your 401(k) account. That’s why retirement savings plans are so popular. Contributing the maximum, particularly in the early years of your plan, will help you grow your money exponentially.
4.Your 401(k) is an asset that can be used for collateral
A retirement savings plan is considered an asset by banks and lending institutions. That means you can use it as collateral for a secured loan or even borrow funds directly from it if your 401(k) provider allows it. The latter action should only be done if you’re in extreme financial distress. Never touch the principal of your 401(k) unless you absolutely need to.
5.Maxing out now will increase your retirement income
The balance of your 401(k) account will determine how much you will be able to draw for income while in retirement. Maxing out your contributions now will increase that income in your golden years. Cut your expenses so you can do this. It’s easier to do when you’re young than when you’re older. Make sacrifices now so you don’t need to when you’re retired.
The Bottom Line
Contributing the IRS maximum to your 401(k) can lower your taxable income, potentially move you into a lower tax bracket, increase your compounded returns, create an asset that can be used as loan collateral, and increase your retirement income. Cutting expenses now to max out your 401(k) can help you live comfortably when you leave the workforce.
Image Source: BigStockPhoto.com (Licensed)
Sources:
https://www.sofi.com/learn/content/strategies-to-max-out-401k/
https://www.entrepreneur.com/business-news/pros-and-cons-to-maxing-out-your-401k/373849
https://meetbeagle.com/resources/post/how-often-does-401k-interest-compound
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