A 401(k) or IRA can be an excellent way to save for retirement and enjoy tax benefits — either for the year of the contributions or when money is withdrawn in retirement. However, the Internal Revenue Service caps the amount workers may contribute to tax-advantaged plans. These limits are occasionally reviewed and adjusted as necessary.
In October, the IRS announced it will increase the amount workers can contribute to tax-deferred 401(k) retirement plans provided by their employers. Beginning in 2018, the limit will be $18,500 per year — $500 higher than the cap in 2017. This is the first increase the IRS has authorized in three years.
A 401(k) retirement plan is sponsored by an employer and allows workers to invest a portion of their paycheck before taxes. Taxes are not paid on contributions until the money is withdrawn. Employees control how their 401(k) account is invested. These accounts have many restrictions and unique features. Most 401(k) plans come with some type of match, which means the employer matches a certain amount of the employee’s contributions. Vesting refers to the amount of time an employee must work for the company before they have access to any contributions the employer makes on their behalf.
This higher limit will also apply to 403(b) plans. This is a tax-sheltered annuity that is available to certain teachers and employees of tax-exempt groups. Thrift Savings Plans (TSPs) for federal government employees and 457 plans provided to local and state government employees like firefighters and police officers will be subject to the same higher cap.
Small business owners and employees along with self-employed workers who use a simplified employee pension plans (SEP IRAs). These plans will have a new cap of $55,000 per year in 2018, an increase of $1,000.
The saver’s credit, or the retirement savings contribution credit, will likewise receive a higher income limit. This tax credit is designed to reduce taxes or increase refunds for low and moderate-income workers. The saver’s credit can be taken for contributions to many types of retirement accounts, such as a 401(k), SEP IRA, Roth IRA, traditional IRA, or 403(b) plan.
How much the saver’s credit is worth depends on the worker’s income and contributions, but the credit can be worth up to 50%. For example, a worker who saves $2,000 for retirement in a qualified retirement account can get a 50% credit to reduce their taxes by $1,000.
Under the new guidelines, the income limit for married couples filing jointly will be $63,000 — $1,000 higher than 2017. The limit for heads of household will rise to $47,250 while singles and married couples filing separately have a new limit of $31,500.
The limit for a traditional or Roth Individual Retirement Account will be unchanged. Since 2015, the limit has been $5,500 or the worker’s taxable compensation for the year, whichever is higher. Workers who are 50 or older can make an additional $1,000 per year in catch-up contributions. This limit does not apply to rollover contributions. Contributions can no longer be made to an IRA after the age of 70-1/2.