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If you’re signing up for next year’s workplace benefits, now is the best time to develop a strategy for increasing your savings.
Benefits season also happens to coincide with the annual IRS release of the 2021 maximum contribution limits for certain tax-advantaged accounts, including your 401(k) plan, individual retirement account and healthcare flexible spending accounts.
Uncle Sam updates these figures around this time each year to reflect inflation.
Be aware that while these maximum amounts may be something for savers to strive for, they’ll need to balance their long-term savings goals with daily cash needs.
You don’t want to shortchange your emergency fund so that you can squirrel away a few more dollars in your 401(k) plan.
“Being able to contribute the maximum is a fantastic place to be, but most people aren’t there,” said Dave Stolz, CPA and chair of the American Institute of CPAs’ personal financial specialist committee,
“There’s this juggling act between how much do you spend, how much you put away for retirement and how much goes into your cash reserve fund,” he said.
A high bar for maxing retirement
Next year, you can defer up to $19,500 into a 401(k), 403(b) and most 457 plans at work, plus $6,500 in catch-up contributions if you’re aged 50 and over.
That’s unchanged from 2020.
You can also save up to $6,000 in a traditional or Roth IRA, plus an extra $1,000 if you’re aged 50 and over. These figures are also holding steady from 2020.
The IRS applies limits on the extent to which high-income individuals can make direct contributions to Roth IRAs – accounts in which you can save after-tax dollars, have them grow tax free and then use them free of tax in retirement.
Those thresholds are also adjusted annually for inflation.
In 2021, if your adjusted gross income exceeds $125,000 and you’re single (or $198,000 if married filing jointly), you won’t be able to contribute the full amount directly to your Roth IRA.
As an alternative, these savers can consider using a strategy known as the “backdoor Roth,” where they make a non-deductible contribution with after-tax dollars to a traditional IRA and then convert it to a Roth.
They could also direct money to a Roth 401(k) plan at work, provided their employer offers it.
There’s a tax benefit to sprinkling some of your cash across Roth, tax-deferred accounts and taxable brokerage accounts: You’re diversifying your tax treatment, which can help you manage your tax bill in retirement.
“Most people would simply save some money in both the tax-deferred and tax-free accounts,” Stolz said. “We don’t know what the future tax brackets will be, but you’re adding some opportunity to get tax favorable treatment across your portfolio.”
Adding to health savings
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If you have a high-deductible health insurance plan next year, you might also have access to a health savings account.
In this case, you save pretax or tax-deductible money into your HSA, where your funds grow tax-free. You’re able to tap the money free of taxes for qualified medical expenses.
There’s a sweetener to using the HSA at work: Contributions aren’t subject to income, Social Security or Medicare taxes.
That’s different from your 401(k) contribution, which avoids income taxes at deferral but is subject to Social Security and Medicare tax.
Next year, you can stash up to $3,600 if you’re an individual with self-only health coverage, according to the IRS. That’s up from $3,550 in 2020.
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Accountholders with family plans can save up to $7,200 in this account, an increase from $7,100 in 2020.
Savers who are 55 and over can contribute another $1,000.
Be aware that HSAs aren’t the same as health-care flexible spending accounts (FSAs). You can roll your HSA balance from one year into the next, accumulating cash you can use in retirement.
Meanwhile, health-care FSAs generally must be used by the end of the plan year.
In 2021, you can save up to $2,750 in your health-care FSA – the same amount as 2020. If your plan allows you to carry unused amounts into next year, the maximum you can carry over is $550.