401(k) Contribution Limits for 2016

Your grandparents had pension plans, you have a 401(k).

It’s a downgrade in some ways. For one, 401(k)s have contribution limits. Also, employees are now responsible for funding their own retirement and face the risks that come with choosing investments. But still, these plans are a valuable retirement savings tool with high contribution limits.

They’re also a source of confusion for many, if the questions to NerdWallet’s Ask an Advisor are any indication. The most common issue? Knowing how much you can — and should — contribute.

401(k) contribution limits for 2016

Because 401(k)s are tax-advantaged, they have a maximum annual contribution set by the IRS each year. So the first question is not how much should you save in a 401(k), but how much can you save? The following limits apply to both Roth and traditional 401(k)s:

Age	Maximum annual contribution
Under 50	$18,000
50 or older	$24,000 (reflects $6,000 catch-up contribution)

Yes, there are two types of 401(k): With the traditional kind, your money goes in pre-tax, but you pay taxes on distributions in retirement. With the Roth version, contributions are made with after-tax dollars, but distributions in retirement are tax-free.

In either case, once that money is in, you should consider it locked away without a key until retirement. The Roth is more flexible about early distributions — as long as you take out contributions, not earnings. But there is a 10% penalty for taking money out of a traditional 401(k) before age 59½; plus, you’ll owe income taxes on the early withdrawal. (There are a few exceptions, as well as the option to take a loan in some cases.)

Decide how much you need to save, period

Most experts recommend saving 15% of your income for retirement. Depending on your salary, that could be more than the annual 401(k) contribution limit — or much, much less.

It’s also a general rule. How much you need to save for retirement depends on a long list of factors. Your life expectancy, your investment risk tolerance and your expected income needs during those years are just a few.

NerdWallet’s retirement calculator can help you ballpark how much you should save, as can going through a few quick steps to write a retirement plan.

Contribute enough to earn the employer match

About 95% of 401(k) plans include some sort of matching contribution from the employer. This contribution is in addition to your salary, and it does not count toward the IRS contribution limits.

Employers typically match between 50% and 100% of the employee’s contributions, up to a cap. Most companies require employees to contribute at least 6% of their salary per year to receive the full match, according to Aon Hewitt, a human resources consulting firm.

If your employer offers matching dollars, the question of how much you should contribute to your 401(k) has an easy answer: at least enough to earn the entire match. This match can make a huge difference over time.

Employee contribution	Employer match	Account value after 40 years without employer match	Account value after 40 years with employer match
6%	50%	$820,254	$1,230,383
6%	75%	$820,254	$1,425,448
6%	100%	$820,254	$1,640,507

(Based on a starting salary of $45,000, 3% annual salary increases and a projected 7% annual investment return.)

Then evaluate your 401(k) plan’s expenses

Even aside from that match, 401(k)s have a lot of benefits. The money you’ve elected to contribute is pulled out of your paycheck before you have a chance to see or spend it.

But these plans also have limitations. Your company will typically curate a small selection of investment options for its 401(k) — mostly mutual funds — which means you won’t have access to the wide variety of investments you can purchase through an IRA or brokerage account.

»MORE: How to invest your 401(k)

This relates to a second knock against 401(k)s: They tend to be expensive. Because of that small investment selection, you don’t have the ability to shop around for funds with the lowest expense ratios; you may be offered only one or two fund choices in each asset category. And your 401(k)s may also have high administrative fees if your employer passes the costs of maintaining the plan through to you. (Some generous employers cover these costs for their employees.)

Consider a Roth or traditional IRA

If you find your 401(k) is lacking in low-cost investment options, such as index funds and exchange-traded funds, or the plan’s fees are pricey, it makes sense to switch to contributing to a Roth or traditional IRA after you’ve captured your employer’s match.

An IRA is another tax-advantaged way to save for retirement, though the account you choose will determine the specific tax benefit: Roth IRAs are like Roth 401(k)s: funded with after-tax contributions, but withdrawals in retirement are tax-free. Traditional IRAs function like — you guessed it — traditional 401(k)s in that contributions are tax-deductible in the year they are made, but withdrawals are taxed in retirement.

» MORE: Is it better to contribute to a Roth or traditional IRA?

IRAs also have annual contribution limits: For 2016 they are $5,500, or $6,500 for those age 50 or older. If you max that out and your calculations show you need to save more, you can then resume contributing to your 401(k) until you hit its limit.

One quick note: If your employer offers no match, you may want to start with an IRA. Once you’ve maxed that out for the year, then switch to contributing to your 401(k).

Reach your goals with gradual increases

Admittedly, maxing out both a 401(k) and an IRA each year is an unlikely feat (though if you did it starting at age 25, you’d be a millionaire by age 43). You may feel like just saving enough to get your full employer match is enough of a struggle.

So work your way up slowly, by bumping up your contribution 1% each year (if you get a raise, try to use some of it to bump up contributions even more.) Some companies even do this for you, by auto-escalating your contribution rate at the beginning of each year. Before you know it, you’ll be saving close to that recommended 15%.

Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: aoshea@nerdwallet.com. Twitter: @arioshea.