The IRS just released the 2020 contribution limits for qualified plans. Why does the IRS limit contributions for qualified plans? Qualified plans allow employees to take advantages of tax benefits, for example; employees that earn a higher salary can use these benefits more than someone that does not earn as much. To combat this issue and make contributions fairer, the IRS sets limits. Listed below is what the IRS released and for the third year in a row contribution limits have increased.
Looking at 401k plans specifically, how often does the IRS increase these limits? And what have the limits looked like in years past? I pulled data from dqydj.com to answer these questions:
Historical Contribution Limits for 401(k) Plans
*Highlighted are the times when the limit was increased.
As shown in the table, within the last 20 years, the IRS has raised the limits 12 times. They do this in response to the consumer price index (CPI). The CPI measures the prices of goods and services from month to month and year to year. As this number increases, things become more expensive and it takes greater capital to make purchases. It is important to be able to invest and beat the cost of inflation. I think of the story about my grandparents going to the store to buy a candy bar for $0.05 compared to the $1.00+ they are now.
What does this mean for your savings or investments? This means you can save more in a tax deferred account. Great news! Let’s see what a scenario would look like: Let’s assume in 2010 you funded a 401k with $1,375 a month ($16,500 a year). We are going to assume 7% return a year and you are saving for 30 years. At the end of 30 years, your account value is $1,616,461.57. Now, let’s look at the new max ($19,500 or $1,625 a month). Again, assume 7% return for 30 years. Your ending balance will be $1,982,452.87. That is over $370,000 by saving $250 more per month. Now, we know that the limits are not obtainable for most people. The main thing that we want you to take away from this is the value of saving more over the long run. For example, if you take the $500 increase for 2020, it means you can save $41.70 more per month in 2020 than in 2019. Calculating the same 30 years and assumed 7%, that $41.70 per month will grow to around $21,500. That just shows that every little bit can count. Everyone must start somewhere; so, get out there and start saving!
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