Higher Contribution Limits Could Make a Big Difference for Retirement

by Dan Wiener | January 5, 2013 7:30 am

While 2013 has just begun, don’t close the books on 2012 just yet, especially if you haven’t contributed all you can to your retirement savings accounts. I bring this up at the start of each new year because I think it bears repeating that tax-deferred accounts such as 401(k)s, 403(b)s and IRAs are unmatched when it comes to saving for retirement, especially for those who regularly add to their accounts through the markets’ ups and downs.

It seems that investors have been getting the message. Fidelity Investments (not Vanguard) is the country’s largest retirement plan provider. The firm reported this summer that, on average, participants in Fidelity IRAs increased their annual contributions by 15% from 2007 to 2011 — which works out to about $500 more set aside per participant. It’s a good thing, too, because Fidelity also revamped its guidelines for retirement savings this year — according to the firm’s calculations, you need to have put away eight times your income by the time you hit age 67 to have a shot at 85% of your pre-retirement annual income available to you after you retire. While I can’t vouch for Fidelity’s math, I do agree with the underlying theme — when it comes to your retirement, the more you can save, the better.

Savings Limits on the Rise

While some superstitious folks consider 13 to be an unlucky number, for those interested in increasing their retirement savings contributions, 2013 brings good fortune. The IRS increased the amount investors can save in 401(k), 403(b) and 457 plans from $17,000 in 2012 to $17,500 in 2013, while IRA and SIMPLE plan account holders also saw their contribution limits increased by $500 from 2012 to $5,500 and $12,000, respectively. These levels, established by the Pension Protection Act of 2006, are a huge improvement over what they were earlier this decade. The pre-2002 limit was set at $2,000 a year for IRAs, $6,500 a year for SIMPLE plans and $10,500 a year for 401(k), 403(b) and 457 plans. You can see how far they’ve risen in the table below.

10 16 13 contr limit Higher Contribution Limits Could Make a Big Difference for Retirement[1]

Will these increased contribution limits make a difference? Without a doubt. Remember that every additional dollar you add to a tax-deferred account is a dollar that can compound on itself, and its gains, for as long as you keep it within that tax-avoiding wrapper.

I’m a big believer in retirement savings plans, contributing the maximum to my own 401(k) as well as my IRA (which I converted to a Roth in 2010) every year. In fact, when I can, I add my 401(k) money early in the year on the assumption that markets rise more often than they fall, hence my desire to buy early, and at the lowest possible price.

Playing Catch-Up

As if the opportunity to increasingly save more of your hard-earned dollars for retirement weren’t good enough news, the fact that folks like me, age 50 and older, can save additional dollars is an added bonus.

For those of us past the half-century mark, we can once again contribute an extra $1,000 to our IRAs in 2013, for a total of $6,500, and the numbers are even higher for other retirement plans (see table below). For those of you who are younger than me and turning 50 in 2013, as well as my peers, take advantage of the option. And if you didn’t do so in 2012, you still have until April 15, 2013, to make the most of this fantastic feature. (In 2012, the limit was $5,000 plus an additional $1,000 catch-up.)

10 16 13 catchup Higher Contribution Limits Could Make a Big Difference for Retirement[2]

In fact, if you don’t think you’ll have the full amount available to contribute for 2013 right away, make sure you take advantage of the maximum 2012 contribution limit first, before adding money for 2013. This way you won’t lose the option should a sudden spot of financial luck or a raise give you additional money which can then be contributed to your tax-deferred account later in the year.

If you’re eligible for the catch-up contributions, talk to your company’s Human Resources or employee benefits department about your in-house retirement account and make sure that they’ll accommodate you. While employers are not required to allow the catch-up contributions, most should be with the program by now.

Regardless of your age or income level, you should strongly consider making your 2013 contributions now, rather than later. And if you still haven’t done all you can for 2012, do that first. Retirement accounts are great long-term savings vehicles, and regular contributions, when properly invested, will really add up over time.

Senior Editor Dan Wiener and Editor/Research Director Jeffrey DeMaso publish The Independent Adviser for Vanguard Investors[3], a monthly newsletter that keeps abreast of recent developments at Vanguard, and the annual FFSA Independent Guide to the Vanguard Funds.

Endnotes:
  1. [Image]: http://investorplace.com/wp-content/uploads/2013/10/10-16-13-contr-limit.png
  2. [Image]: http://investorplace.com/wp-content/uploads/2013/10/10-16-13-catchup.png
  3. The Independent Adviser for Vanguard Investors: http://investorplace.com/order/?sid=HK8361

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