Recently we learned that Social Security recipients will receive a 1.3 percent cost of living adjustment (COLA) next year. Annual COLAs are based on specific inflation data from the Bureau of Labor Statistics, and the government will sometimes make similar adjustments to the annual limits on the dollar amount of contributions that can be made to popular tax-advantaged savings vehicles.
With 401(k) plans, for instance, current law allows individuals to contribute up to $19,500 each year (plus another $6,500 for participants ages 50 and older). As for IRAs, the annual cap is $6,000, along with an extra $1,000 in catch-up contributions for older savers. Such ceilings are required by law to be adjusted annually if necessary for cost of living increases, but inflation was not high enough in 2020 to warrant a change in the above-mentioned limits. This is not some rare side-effect of the pandemic because contribution caps by design should not change as frequently as Social Security recipients receive cost of living adjustments unless inflation pressures are increasing significantly.
There were a few adjustments to income ranges for determining eligibility to make deductible contributions to certain plans, and more details on these and various other alterations that will occur in 2021 can be found in IRS Notice 2020-79. As for the majority of retirement savers who do not contribute anywhere near enough to worry about annual limits it is still important to remember that every additional amount of money they set aside, no matter how seemingly small, can ultimately have a big impact on old-age financial security. For example, an earlier NerdWallet analysis estimated that a 30-year-old who starts investing an additional $500 each year (just $42 a month) could have an extra $70,212 by the time he or she retires.
Even for those unable to start until age 40 investing just $500 more every year could still add $34,712 to their retirement nest egg, according to the report. Most 401(k) participants are already far enough below the annual limit to easily allow for additional contributions, and a growing number of retirement plan sponsors are utilizing automatic features to nudge workers into better savings rates. Such measures are highly effective, as evidenced by a J.P. Morgan study which found that only 1 percent of workers who were automatically enrolled in a defined contribution plan opted out, and just 6 percent of participants whose contributions were automatically escalated decreased their deferral rate.
Sources: U.S. IRS, NerdWallet, J.P. Morgan