Getting To Know The 401k Contribution Limits
Another type of retirement plan is the 401(k) plan; its name is taken from a section of the Internal Revenue Code. It is an elective plan where the employee determines the amount the employer will pay directly or defer into the 401k account. The money you elected to be contributed into a 401k is deducted from your pre-tax compensation.
401k contributions are also a means of lowering your taxable income. For example, you are receiving a salary of $2,000 and you elect to contribute about 5% of your salary that leaves you with about $1,900 in taxable income. Contributions to the 401k and its subsequent earnings are also income tax free
There are 401k contribution limits and there are two types of contribution limits. The first limit is the one marked by your employer and the other 401k contribution limit is the one set by the Internal Revenue Service or IRS.
The Government’s 401k contribution limit is $15,500 for those under 50. There is a $20,500 catch-up contribution limit for those over 50. The reason for the catch-up contribution is the presumption that when you reach 50 years of age your earning ability can well compensate for an increase in your contributions. Another type of 401k contribution limits is the one set by the employer. An employer can set-up limits for your contributions, for example if you are a 35-year old employee receiving $40,000 in compensation and your employer sets a maximum allowable contribution of 10% of your compensation, it means your maximum 401k contribution limit is only marked at $4,000 even though there is a higher IRS limit. But what if you are a 35-year old employee and you are earning $400,000? If you follow your employer’s contribution limit then your contribution limit would be about $40,000. However that contribution limit is not allowed since the Government’s 401k contribution limit is pegged at only $15,500. Thus, the general rule is you can follow your employer’s 401k contribution limits as long as it never goes beyond the prescribed contribution limits of the IRS. You must remember that contribution limits are determined by the prevailing IRS limits, your plan and your amount of salary You must also take note that the Government is increasing its contribution limits every year. After 2007, the contribution limits will be indexed for inflation purposes and increments of at least $500 will be applied to the limits. If the plan’s contribution limit for 2007 is set at $15,500 then for 2008 it will be at $16,000. 401k allows employers to contribute to the employee’s 401k account, these are called “company match” and are used to entice the employee’s to participate in the account or as attractive sweeteners to retain or attract prospective employees. An employer’s contribution match of up to 6% of its employee’s pre-tax salary is deposited above and beyond your contributions, which means it would not affect your 401k contribution limit. If you are contributing in excess of your 401k contribution limits in a given year then you have until April 15th of the following year to remove that excess contribution. It usually happens when an employee shifts jobs in the mid-year and the new employer has no knowledge of the contribution limits of its new employee, failure to take out excess contributions will result in the employee paying penalties and taxes.
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