Saving for retirement is a top financial priority for many. If you’re one of those who has prioritized retirement by opening a Roth 401(k), it’s crucial to use the account optimally to build tax-free retirement income. The IRS has raised the annual contribution limit for Roth 401(k)s to $22,500 for 2023. Here are more details on the contribution limit and how you can take advantage of this unique retirement account. You can also work with a financial advisor who can advise you about your best retirement choices.
What Is the Roth 401(k) Contribution Limit for 2023?
A Roth 401(k) is an employer-sponsored retirement account that uses post-tax dollars. Unlike a traditional 401(k), to which you would contribute pre-tax dollars, a Roth 401(k) allows you to pay taxes first and make tax-free withdrawals in retirement.
The IRS limits the amount you can deposit to this tax-advantaged account. See below the limits for 2023 and a comparison from last year:
Roth 401(k) Contribution Limits: 2023 vs 2022
|Roth IRA Income Thresholds|
|Type of Contribution||2023 Limit||2022 Limit|
|Roth 401(k) Contributions||$22,500||$20,500|
|Catch-Up Contributions (over age 50)||$7,500||$6,500|
The IRS has increased the contribution limit by $2,000 from last year. As a result, you can adjust your monthly contribution to maximize your Roth 401(k) to the new limit. Additionally, if you’re 50 or older, remember that you can take advantage of additional catch-up contributions of up to $7,500.
So, workers age 50 and up can contribute a maximum of $30,000 to their Roth 401(k) in 2023. Remember, the contribution limit counts toward Roth and traditional 401(k) plans. Therefore, your contributions to both plan types must add up to $22,500 or less. This rule is helpful to keep in mind if you want to contribute to both types.
Should You Max Out Your Roth 401(k) Contributions?
Saving for retirement is vital for your financial plan and contributing to your Roth 401(k) is an excellent idea to help you get there. However, maxing out your contributions might strain your finances and achieving financial health means balancing priorities. For example, it’s essential to knock out debt and save for other goals, such as a down payment for a house. Therefore, contributing the full $22,500 might not be optimal.
Instead, it’s recommended to contribute enough to take advantage of matching funds, if possible. You don’t want to leave free money on the table, so allocating enough money each month to receive the full match from your employer can provide exponential growth to your retirement account. In addition, other retirement vehicles can offer more flexibility and profitability.
Employer-sponsored retirement plans can restrict your investment choices, while individual retirement accounts (IRAs) allow you to invest in funds that fit your preferences. If you have enough income, it might be best to contribute enough to your 401(k) to receive matching funds and deposit another chunk of cash into an IRA.
Tax and Investment Benefits of a Roth 401(k)
With a traditional 401(k), you defer taxes on your investments until retirement. This style offers the benefit of delaying taxation until later in life when your tax bracket might be lower. On the other hand, a Roth 401(k) uses money after the IRS taxes it. In other words, a Roth 401(k) has you pay taxes now so you don’t have to worry about them later. Plus, the IRS doesn’t tax earnings in a Roth 401(k). You can then withdraw from your Roth 401(k) during retirement without increasing your income taxes. But, if you withdraw funds before age 59.5 or before owning the account for five years, you’ll pay a 10% penalty.
Unlike a Roth IRA, a Roth 401(k) has a higher contribution limit and no income limitations. Specifically, the 2023 contribution limit for Roth IRAs is $6,500 and $7,500 if you’re 50 or older. Plus, individual tax filers with a modified adjusted gross income (MAGI) of $153,000 or more and married filers with a MAGI of $228,000 or more are not eligible to contribute to a Roth IRA. Roth 401(k)s don’t have an income limitation and the contribution limit is $22,500 instead of $6,500. Therefore, Roth 401(k)s don’t exclude investors based on income and they allow you to invest more.
Roth 401(k) Contribution Limits for Employer Matching and Highly Compensated Employees (HCEs)
Highly compensated employees (HCEs) must abide by income-based regulations when contributing to their Roth 401(k). Highly compensated employees are those who own more than 5% of the company or earn more than $150,000 from the company. In some cases, HCEs are also among the top 20% highest paid in the company.If you’re an HCE, the non-HCEs in your company will influence how much you can contribute to your Roth 401(k). Namely, your contributions cannot be more than 2% higher than the average Roth 401(k) contributions by non-HCEs in the company.
Consider Other Retirement Accounts
Because laws regarding income and employee contributions can limit HCEs from building up their Roth 401(k)s, it’s a good idea to consider other options. For instance, you might have a low enough MAGI to contribute to a Roth IRA. In addition, you can open a traditional IRA, which uses pre-tax dollars and has no income stipulations.You can also open a brokerage account.
Although the IRS taxes these accounts, you can hold assets for more than a year and receive long-term capital gains tax rates, which are lower than income tax rates.In most cases, allocating some investment money to an investment account other than your Roth 401(k) helps diversify your investments.
A diversified portfolio is advantageous because it mitigates risk. Plus, it can diversify your tax risk so future tax law changes won’t hurt your financial circumstances as much. Remember, if you’re struggling to get a better handle on your retirement plan, you can work with a financial advisor to help you achieve your goals.
The Bottom Line
The IRS has increased the Roth 401(k) contribution limit to $22,500 for 2023. Contributing to this account can garner matching funds from your employer and create tax-free income during retirement. Plus, you can pair this account with other investments to diversify your portfolio and sidestep issues if you’re an HCE. Overall, if you have a Roth 401(k), it’s wise to take advantage of this unique account, as not everyone’s employer offers it.
Tips for Contributing to Your Roth 401(k)
- It can be challenging to discern exactly how much you should contribute to your Roth 401(k). Competing financial priorities and opportunities can stress your decision-making. Fortunately, a financial advisor can get you on the right track. If you don’t have a financial advisor, finding one doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- A 401(k) is just one option for retirement savings. An individual retirement account, or IRA, functions like a 401(k) but it isn’t attached to your employer. Plus, you can choose any stocks, bonds and indexes you want without restriction, giving you freedom as an investor.
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