Updated: Nov 21, 2019
This week the IRS has announced the 2020 changes to pension and retirement plans
Retirement Plans in 2020
By now, we should all know that I am a fan of the tax advantaged 401(k) plans and I'm sure you are too! Therefore it's exciting to read that in 2020 our contribution limits are going up! In short, we will be able to contribute $19,500 next year, an increase of $500 from the year prior. There are many other changes like catch up contributions and highly compensated employee thresholds that also changed and can be found with Notice-2019-59 here.
Your 2020 Action Plan
You should always check with your 401(k) plan first, because each one is different, but for the majority 401(k) plans benefit the most when the $19,500 limit is spread among each paycheck to maximize the employer match (this may not be true if you are in the upper echelons of earners or if your plan allows front-loading). The table below is how much a weekly, bi-weekly, or monthly paid employee can contribute to maximize 401(k) potential.
401(k) Match Max Contribution per Check
Weekly (52 Pay Periods): $375.00
Bi-Weekly (26 Pay Periods): $750.00
Monthly (12 Pay Periods): $1625.00
The Decision Making Process
Annually, the Secretary of Treasury decides a cost-of-living adjustment (COLA) based on the Consumer Price Index. If a notable increase is determined it effects a wide variety of retirement plans and options. For example, a modest increase in COLA places an increment, in multiples of $500, on 401(k) contribution limits (where $500 has been used since the late 1990's to adjust for inflation, or in this case COLA).
Isn't it funny how we use an increment of $500 multiples? Why wouldn't we want a value the more accurately corresponds to the adjusted cost of living? For instance, if 1997 had a 1.6% COLA we would have increased the contribution by $500, same as today. With inflation, $500 in 1997 dollars has the same buying power as $796.40 in 2019 dollars (as depicted in the graphic below from the BLS).
What Would Increases Look Like Adjusting
To increment the 401(k) limits more appropriately to the cost-of-living projections a solution could be to multiply the previous year increase by the COLA multiple. For example if we expected a 1.6% COLA we could: Increment from last year * (1 + COLA) = Increment for next year
This method would result in an increment of $792.85 (most likely due to rounding differences) for this year which is much closer to the inflation adjusted number. Not only is this in line with the cost-of-living but it gives employees a higher return by the end of their career. We want to emphasize that this is how mathematically we lessen the standard deviation and grow the increments with COLA and not whether we should or not. There may be economic forces that would alter the effectiveness of doing so.
As an Amazon Associate I earn from qualifying purchases.