Yesterday I talked about how we'll be contributing to a Roth IRA first this year as part of our retirement plan. I believe that unless you have a company matching 401k contribution, a Roth IRA will usually have more investment options, have less restrictions, and because it's done with post tax dollars, you'll never have to pay taxes on the contributions or the earnings. There are a lot of great reasons to invest in a Roth IRA, but once we reach the $5000 contribution limit for our Roth IRA, we also wanted to diversify our tax situation and invest in my company 401k as well.
Today I thought I'd talk briefly about some of the 401k rules, regulations and contribution limits.
What Is The 401(k)?
So what exactly is a 401(k)? It is a retirement savings account type. From Wikipedia:
A 401(k) is a type of retirement savings account in the United States, which takes its name from subsection 401(k) of the Internal Revenue Code. 401(k)s were first widely adopted as retirement plans for American workers, beginning in the 1980s. The 401(k) emerged as an alternative to the traditional retirement pension, which was paid by employers. Employer contributions with the 401(k) can vary, but in general the 401(k) had the effect of shifting the burden for retirement savings to workers themselves. In 2011, about 60% of American households nearing retirement age have 401(k)-type accounts.
401(k) Contribution Limits
The 401(k) account type has contribution limits associated with it. The 401k contribution limits have remain unchanged from 2010 to 2011. Here is a table showing the maximum yearly contribution for the 401k account type every year since 2007.
|Year||401k Contribution Limit|
As you can see it has been increased by $1000 over the past 5 years. No significant changes are expected for 2012, but we'll have to wait til the end of the year to find out for sure.
401(k) Employer Contribution Limits
Many employers will also offer a contribution to employee's 401(k) accounts. Currently the employer can contribute to an employee's 401(k), only subject to the maximum contribution of $49,000 (for 2011) for the employee.
Highly compensated employees may be subject to other restrictions put in place by an employer's plan.
401k Catch-Up Contribution Limits
For workers who will be 50 years or older by the end of the 2011 tax year, you will also be eligible to make catch-up contributions to your 401k. It should be noted that not all employer sponsored plans allow this, so you'll need to check with your company's plan to make sure it is allowed. Here is a table with the current year's 401k catch-up contribution limits.
|Year||401k Catch-Up Contribution Limit|
Do Employer Matching Contributions Affect Your Limit?
A lot of employers will offer contributions or match your contributions to your 401(k), up to a certain percentage. The question is – do those contributions affect the employee's contribution limit, or is it a separate limit? Thankfully it is a separate limit.
Example: If someone makes $100,000 in pre-tax compensation, and they and their employer both contribute the maximum, they could have $16,500 contributed by the employee, and $6,000 by the employer for a total of $22,500. If they're over 50 they could also make catch up contributions for a total of $28,000.
Other Things To Consider
There are other things you may need to consider with your company's 401(k) plan. For example, if you're a highly compensated individual at your company you may be subject to separate contribution limits. Some plans may allow you to make post tax contributions to your account. Currently the max you can contribute to a401(k) plan is $49,000 or 100% of your compensation, whichever is less.
Are you currently contributing to a 401(k) plan through your work? Are you contributing to the maximum? Do you get a company match? Tell us what you think about the limits, and if you'll be able to reach them.