Your 401(k) might look a little different in 2023—and that could be a good thing for long-term gains after a year of economic challenges and the bite of inflation.
In December, the IRS announced 401(k) annual contribution limit increases for 2023 for employees who have access to such a plan. This includes:
- The amount individuals can contribute to 401(k), 403(b) and other tax-advantaged employer savings plans will increase to $22,500—up from $20,500 in 2022.
- People 50 and older can make catch-up contributions of $7,500 beginning the calendar year they turn 50. This is an increase from $6,500 in 2022, with a max contribution up to $30,000 per year.
“This is a big increase for employees—more than 10%—and is a reflection of the high inflation rates we’re seeing this year,” said Brandy Marion, retirement plans education manager at BOK Financial®. “The increase is the largest we’ve seen in decades.”
The annual inflation rate rose from 7.5% in January of this year to 8.2% in November, signaling an overheated economy and spurring the IRS to also increase tax brackets for 2023.
“What it comes down to is that inflation causes all of us to pay more for food, energy and rent, but it also brings changes like these to the forefront, which can be viewed as the ‘good’ side of inflation,” Marion said.
The 401(k) increases also come on the heels of a cost-of-living-adjustment (COLA) increase for Social Security beneficiaries—the biggest since 1981. The 8.7% increase will benefit more than 70 million Americans.
“Contributing to your 401(k) helps prepare you for retirement and provides tax advantages in the long run,” Marion said. “It’s important to check in on your account periodically and be attuned to this type of change to be sure you’re taking advantage of every opportunity you can.”
If you’re not already contributing to a 401(k), now is the time to investigate taking advantage of the long-term benefits, Marion said. “Even if you’re not maximizing your contributions, if your employer offers to match a percentage, you should contribute enough to earn the match. By not taking advantage of this benefit, you are missing out on ‘free money.’”
Increasing your 401(k) contributions will also reduce your taxable income. “The more you increase contributions from your pre-tax income, the less you’ll be taxed on the remainder,” Marion said. If you make $2,000 a paycheck (pre-tax) and put 10% into your 401(k) now, you’re taxed on $1,800. Even a 1% increase in your contribution rate can make a difference in the long run, she said.
Bottom line, says Marion: Review your 401(k) contributions regularly. “Now is the time to go in and see how much you’re contributing and make changes based on your needs going into the new year,” she said. Other tips:
- The increase from the IRS doesn’t include employer matching. “It’s important to note that the increase is only for the employee contribution portion, so an employer match can go above that amount,” Marion said.
- Are you retiring in the next 10 years? Then you might need to revisit your selections.
- Avoid front-loading your contributions. In most situations, employee matching is done per pay period, so front loading your contributions may mean you’re not eligible for employee matching – and this could mean missing out on a lot of “free money” throughout the year to help grow your retirement account.