Planning your 401k is more secure than using a piggy bank

Guidelines on 401k Contributions, Limits, and Rules

Limits on 401k contributions can vary and are based on three different types of restrictions—those placed on the employee, those placed on the employer and, finally, those related to pre-tax contributions versus after-tax 401k contributions.

401k Contributions and Limits

A person who is planning on having a great retirement needs to be a part of a 401k plan. There are two main 401k limits. They are compensation and contribution limits. The compensation 401k limit may not apply to you according to specific rules. This means that you are eligible for a plan no matter how much money you want to deposit as long as your employer offers the plan. But if you make a lot more than other people in your field and are considered highly compensated employee, then you could be subject to a form of compensation limit. This is all according to any compensation rates that your employer pays.

The contribution limit is based on three different 401k rules. The first one is in reference to the limits that are placed on the employee. The second one of the 401k rules is in reference to the limits that are placed on the employer. The third one of the 401k rules is in reference to pre-tax contributions versus after-tax 401k contributions.

Pre-tax vs. After-tax Contributions

The first difference is that the pre-tax contributions are deducted from your gross wage and after-tax 401k contributions are deducted from your net wage. The second difference is that the pre-tax contributions lower your current taxable income and after-tax contributions do not lower your current taxable income. The third difference is that the pre-tax contributions mean that your ordinary income will be taxed when you withdraw money from your plan. After-tax 401k contributions means that you do not have to pay any taxes when you withdraw any money from your plan. The fourth difference is that the pre-tax contributions have a lot of restrictions and after-tax 401k contributions do not have any restrictions.

401k Guidelines

There are many details to consider about a 401k plan. The first to consider is higher contribution limits. There are the catch-up limits that allow older employees to contribute a higher portion of their income into the plan. There are pre-tax and total contribution limits and the limits that apply to the higher paid employees on a company of a 401k plan. The keystone benefit is tax deductible contributions; you do not pay taxes on your contributions during your earning years. Another tax benefit is that the money you earn on your contributions are also tax deferred. The taxes are paid at a later date when you begin withdrawals, hopefully, when you are in a lower tax bracket.

Roth 401k plans, on the other hand, save the tax benefit for further down the road. Instead of paying taxes when you withdraw funds from a Roth 401k, individuals pay taxes at the time of the contribution. After retirement, individuals can then withdraw those funds without having to pay taxes on them as is the case for traditional 401k plans. Essentially, depositing contributions into these types of accounts function as a tax benefit for your future self. That's assuming you retire at a higher income level bracket than when you made the contributions.

The contribution limits change every year. As of 2015, employees up to age 49 can contribute up to $18,000 per year. If you are 50 or older, you are allowed an increased “catch up limit” of $59,000.

Flexibility and Advantages of a 401k

The 401k plan offers contribution flexibility; this means you can decide what level of contribution percentage you are comfortable with. Therefore, you can decide how much money you want to put into your retirement account. For special considerations, like making a house down payment, you can use your 401k for access to tax-free loans. This money must be paid back to the plan, however, in order to not to be penalized. If you leave one company and move to another, you can rollover your old plan into your new company plan.

You can also convert your old plan into an IRA plan if you like. Retirement plan consolidation means that all of your different retirements plans can be put together to make one big retirement plan if desired. When retirement finally comes, the 401k plan gives you the flexibility to decide what kind of withdrawal rate you are comfortable with; you get to make that decision. Talk with your HR person for more details on your company 401k. It is a waste of money not to take advantage of this tax benefit.

Last Updated: August 01, 2017