COLUMN-A reminder from the IRS that you should not ignore
By Mark Miller
CHICAGO Oct 23 (Reuters) - When the Internal Revenue Service talks, Americans generally listen. But many will ignore the message the agency sent last week: You can save more in your tax-qualified retirement accounts next year.
The IRS announced a $500 cost-of-living increase for the maximum tax-qualified contributions for 2013: $17,500 for 401(k) accounts and $5,500 for IRAs.
Most retirement savers are not contributing anywhere near those limits. Mutual fund company Vanguard reports that just 12 percent of participants in plans it administers socked away the maximum in 401(k)s last year - and the median deferral rate among workers participating in the company's plans was just 6 percent, which works out to $3,000 for a worker earning $50,000. But even among workers with gross income above $100,000, the average deferral rate was just 8.2 percent last year.
In part, the low saving rate reflects stagnant growth in median incomes, the rising cost of health insurance and college tuition, and other competing pressures on take-home pay. Those pressures will grow next year, when the stimulus-related payroll tax holiday is scheduled to expire. That means workers' tax rates will revert to 6.2 percent from the current 4.2 percent.
But the low contribution rates also reflect plain old inertia among some retirement savers. So if the $500 IRS bump reminds retirement savers to do a check-up on workplace accounts and IRA contributions for the year ahead, it would be a positive.
"Whenever I talk to people about this, there are many who can't hit the contribution limit," says Dan Keady, director of financial planning at financial services firm TIAA-CREF. "But even if you're not at the maximum, you can use this as an opportunity to increase your contribution for next year by $500. If you're paid twice a month, that's $21 per paycheck."
Seven out of 10 investors age 21-50 say saving for retirement is their top financial priority, according to a survey by money manager T. Rowe Price released last week. But 68 percent are contributing 10 percent or less of their pay; most financial planners will tell you the ideal is at least 15 percent.
Chalk up some of this to the growing popularity of auto-enrollment among 401(k) plans. While it has increased participation rates sharply, the default contribution rate in most of these plans is just 3 percent, and many do not have auto-escalation features.
"Saving 3 percent a year for retirement is like going to the gym for six minutes," says T. Rowe Price senior financial planner Stuart Ritter.
Ritter offers this scenario: A worker starts a job at age 30 and is auto-enrolled in her workplace plan, with a default contribution rate of 3 percent. Her starting salary is $50,000 per year, and she gets a 3 percent raise every year. If she never changes that 3 percent contribution rate - and if she earns a 7 percent annual return on the portfolio - she will retire at age 65 with $315,000.
But if she increases the contribution rate by 2 percentage points every year until she is putting in 15 percent, she will have a much larger retirement nest egg of $1,367,000 at age 65 if all the other variables stay the same.
Some key IRS rules to remember if you are looking to increase your retirement savings next year:
- Catch-up contributions: Savers who turn 50 next year will be eligible to make additional "catch-up" contributions of $5,500 to workplace plans, or $1,000 to an IRA. Those rates are unchanged from 2012. Just 16 percent of eligible savers utilized catch-up contributions in 2011, according to Vanguard.
- Income eligibility: If you have a workplace plan and contribute to an IRA, you can fully deduct your contribution if your modified adjusted gross income, or MAGI, is $59,000 or lower. For married couples filing joint tax returns, those MAGI limits go up to $95,000 for a spouse covered by a workplace plan; a spouse not covered by a workplace plan can fully deduct IRA contributions with MAGI up to $178,000.
- Roth IRA contributions: The income ceilings for Roth contributions also will rise next year. Single filers with MAGI up to $112,000 can contribute the maximum $5,500; married filers with income up to $178,000 can each make a full individual contribution.
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