Retirement savers will be eligible to contribute $500 more to 401(k) plans in 2020. The 401(k) catch-up contribution limit will also increase by $500, which means older workers can defer paying income tax on an additional $1,000.
Here's how the 401(k) plan limits will change in 2020:
-- The 401(k) contribution limit will increase to $19,500.
-- The 401(k) catch-up contribution limit will grow to $6,500 for those age 50 and older.
-- The limit for employer and employee contributions will be $57,000.
-- The 401(k) compensation limit will climb to $285,000.
-- The income limits for the saver's credit will increase to $32,500 for individuals and $65,000 for couples.
Pay attention to these new 401(k) rules when making retirement savings decisions for 2020.
The 2020 401(k) Contribution Limit
The contribution limit for 401(k)s, 403(b)s, most 457 plans and the federal government's Thrift Savings Plan will increase from $19,000 in 2019 to $19,500 in 2020. Workers can defer paying income tax on approximately $42 more per month as a result of this change.
"The main thing for employees to know at the beginning of the year is what their maximum allowable contribution is," says Eric Maldonado, a certified financial planner for Aquila Wealth Advisors in San Luis Obispo, California. "Then update your percentage or dollar-based employee deferrals to automatically fund your 401(k) each pay period."
You can contribute to multiple traditional 401(k) and after-tax Roth 401(k) accounts in the same year, but your total 401(k) contributions to all accounts can't exceed the annual 401(k) limit.
Rob DeLucas, a certified financial planner for Afton Advisors in Brentwood, Tennessee, says, "A Roth 401(k) strategy actually allows you to get even more money into the plan because ultimately all of the money saved will belong to the participant without future deferred taxation."
Traditional 401(k) distributions are taxed when the money is withdrawn. If you deposit more than the contribution limit, take care to withdraw the excess funds by April 15 of the year after you make the contribution to avoid additional taxes and penalties.
The 2020 401(k) Catch-Up Contribution Limit
Workers age 50 and older are eligible to make catch-up contributions to 401(k) plans. The catch-up contribution limit will be $6,500 in 2020, up from $6,000 in 2019. Older workers can defer paying income tax on as much as $26,000 in a 401(k) plan in 2020.
"If you have preset your savings limits at a fixed amount based on plan maximums, make sure you pay attention to your own age. Once you cross age 50, you can contribute a full $26,000 into your employer's 401(k) plan starting in 2020," DeLucas says. "This can certainly help offset savings deficiencies in a worker's overall retirement planning strategy." An older worker would need to save $2,167 per month, or $1,083 per bimonthly paycheck, to max out a 401(k) plan.
The 2020 401(k) Limit for Employer Contributions
Employers can make matching and nonmatching contributions to a 401(k) plan on behalf of employees, even if the worker has already maxed out the account. The overall contribution limit to 401(k) plans, including employer and employee deposits, is 100% of the participant's compensation or $57,000, whichever is lower. For workers age 50 and older, the overall contribution limit is $63,500, which includes catch-up contributions.
The 2020 401(k) Compensation Limit
Highly paid employees may be restricted in their ability to make 401(k) contributions. A 401(k) plan can elect to stop salary deferrals once a participant's compensation reaches $285,000 in 2020 and can only use up to this amount when providing a 401(k) match.
"The catch-up contribution is a great benefit for highly compensated employees because unlike the first $19,500 of contributions that may be limited by their employer, the $6,500 catch-up contribution is available to any employee over 50, including highly compensated employees," says Danielle Seurkamp, a certified financial planner for Well Spent Wealth Planning in Cincinnati. "Considering these workers tend to be in higher tax brackets, the catch-up contribution could save them up to 40 cents on each dollar they contribute."
[Read: How to Set Up Your First 401(k).]
How to Qualify for the Saver's Credit Using Your 401(k) Plan
Low- and moderate-income retirement savers can earn between $500 and $1,000 more and still qualify for the saver's credit, which could be worth as much as $1,000 for individuals and $2,000 for couples. The income limit for the saver's credit will increase to $32,500 for individuals, $48,750 for heads of household and $65,000 for married couples in 2020.
This tax credit is worth between 10 and 50 percent of 401(k) contributions up to $2,000 for individuals and $4,000 for couples, with the biggest credits going to the savers with the lowest incomes. The saver's credit can be claimed in addition to the tax deduction for saving in a traditional retirement account.