Why You Should Max Out Your Retirement Accounts
Maxing out your retirement contributions can be a key step towards building wealth for the future. Plus, it allows you to get the most out of your money due to compounding interest and tax advantages.
Contributions to Traditional 401(k), Traditional 403(b), and Traditional IRA accounts are typically tax-deductible, which means you normally don’t pay taxes until you make withdrawals. The more you put in, the more you might end up with in dividends and appreciation.
How much you contribute to your retirement account now can make a big difference over time. The biggest asset anybody has in investing is time. The earlier you invest, the more possibility there is for your investments to appreciate. This is especially true for retirement savings, because when you use tax-advantaged retirement accounts, such as IRAs or 401(k)s, all that time spent in the market can lead to benefits in tax-free growth.
By the time you reach your 60s, your plan for reaching retirement generally benefits less from time in the market, which means to reach your goal, you will need a higher amount of savings. No matter your age, you should consider taking full advantage of each yearly maximum contribution limit on tax-advantaged retirement accounts.
Let’s explore the major considerations when it comes to maxing out retirement accounts.
1. Compound interest alone is a reason to save early.
The more you deposit into a retirement account, like an IRA, the more you can grow your account in dividends and compounding interest over time. The greater the investment, the more interest and dividends you can earn, which in turn can lead to greater amounts of earned interest and dividends. Betterment automatically reinvests dividends, which helps make compounding very easy to manage. As you max out your retirement accounts from year to year, your money will work harder for you due to this compounding effect.
2. Every year you miss out on is a lost opportunity in tax advantages.
Annual contributions to Traditional 401(k) and Traditional 403(b) accounts are typically tax-deductible. Traditional IRA contributions may be tax-deductible depending on both your status in an employer-sponsored plan and your level of income. You normally pay taxes when you take withdrawals in retirement, which means you typically pay less in taxes today and a larger portion of your income gets to grow during that time. But these contributions are limited from year to year, so you only have within each calendar year to make a contribution.
Contributions to Roth 401(k), Roth 403(b), and Roth IRA accounts are not tax-deductible—you contribute on an after-tax basis—but they grow tax-free. Maxing out these accounts might mean that you end up with more tax-free money in the long run, compared to Traditional accounts. It’s worth noting that Roth IRAs are only available to people below a certain income level, so it’s key to know the rules before making a contribution.
Run the numbers to see if you could benefit more from a Traditional account with an immediate tax benefit, or if you might do better taking the long-term benefits offered by a Roth account.
3. Be aware of retirement account contribution limits.
Annual contribution limits for retirement accounts are set by the IRS and are subject to change each year, so being aware of the limits ensures that you are maxing out your accounts to their full potential.
The maximum amount you can contribute to a 401(k) or 403(b) is $19,000 for 2019. For 2020, the maximum is increasing to $19,500. The catch-up contribution limit for people age 50 or older is $6,000 for 2019 and the catch-up contribution limit is increasing to $6,500 for 2020. This creates a combined limit of $25,000 for 2019, and $26,000 for 2020—for people age 50 or older.
You may also be able to contribute to your IRA as well. For both Traditional and Roth IRAs, the maximum you can contribute is $6,000 for both 2019 and 2020. The catch-up contribution is $1,000 for people age 50 or older, bringing their total to $7,000 for 2019 and 2020. Contribution limits include other stipulations worth reviewing.
4. Contribute incrementally over time in order to reach your goal.
Most of us aren’t able to start contributing the maximum amounts immediately or even in one lump sum. However, it’s possible to use time to your advantage to build toward maxing out your retirement contributions for the year. You can grow your contributions by increments each paycheck or each month. If your employer offers a match, do what you can to obtain the maximum match amount. This is free money that can be used to build your retirement nest egg.
From there, figure out how much you need to set aside each month to max out your contributions, and make that number your goal. Setting up an automatic deposit can help make the monthly contribution an easier process.
Let’s get started, together.
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While Betterment is a financial advisor, we are not a tax advisor, so this article should not be considered tax advice—it’s just informational. Visit our 2019 Tax Filing Support Guide for more information about preparing for tax time at Betterment, and visit IRS.gov for more tax information.
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