As with any financial investment, there are both advantages and disadvantages to contributing to a 401k. You have to know the rules before taking that leap into the retirement savings pool! The question then becomes, how much should you contribute to your 401k? How about a specific amount for each pay period or as a lump sum throughout retirement?
Knowing the contribution limits to your 401k plan can help you make sound investment decisions. The best way to start is by knowing the income tax brackets for your area for both your employer-sponsored and self-employed 401k plans. There are limits to both types of plans, of course, so make sure you’re aware of what those brackets are before deciding how much to contribute. Many employers offer their employees a special supplement to their retirement plans called EFRBS (Employee Retirement Benefits Tax Simplified), which automatically adjusts your contributions to both the employer and self-employed plans.
If you are unsure about how to determine the maximum amount you are allowed to contribute, consult a qualified financial advisor, like a tax consultant or a lawyer. Both can help you calculate the amount you should be contributing based on your family’s net income, your annual salary, and your age. When you take your income and total expenses into account, it will be possible to see if your pension and other benefits are greater than the contribution limit for your plan. If not, increasing your personal contribution amount by only the amount necessary to achieve the same level of pension at retirement may be an option you should consider.
The next question to ask is what are the alternative ways you could contribute if you are exceeding your contribution limits? Self-employed 401k plans can offer an additional money-saving option: the self-directed IRA. It allows you to invest in real estate, certificates of deposit (CDs), money market accounts, and more without taking additional risks. If you are considering a self-directed IRA, talk with a financial advisor about the pros and cons of each option.
There are many other options available to you as a self-employed worker, but it helps to know what’s available so you don’t end up paying too much tax or sacrificing too much of your retirement funds. In general, if you are unsure about how much to contribute, start with a traditional IRA. An IRA is less complicated and offers greater flexibility; plus, it has more affordable monthly fees than a Roth IRA.
One important thing to keep in mind is that the maximum amount of contributions you can make each year is the total of your wages and salaries, plus your IRA contributions. If you have no investments in other things like a pension or savings account, you can make up for it by increasing your annual contributions. Talk to a financial advisor about how best to take advantage of your tax deferral. It is helpful to know how the current rules in place affect retirement account eligibility and total combined contribution limits.
401(k) Contribution Limits by Year
| Category | 2017 | 2018 | 2019 | 2020 | (Est.) 2021 |
| Contribution Limit | $18,000 | $18,500 | $19,000 | $19,500 | $19,500 |
| Max. Employer Contribution | $36,000 | $36,500 | $37,000 | $37,500 | $38,000 |
| Max. for total Contributions (without Catch-up) | $54,000 | $55,000 | $56,000 | $57,000 | $57,500 |
| Catch-up Contribution for employee over 50 years old | $6,000 | $6,000 | $6,000 | $6,500 | $6,500 |