What Are The Yearly Contribution Limits For A 401K?

What are the yearly contribution limits for a 401k? A 401k plan may sound like a wonderful idea if you are among the highly paid and can contribute as much as you like - but there are maximum yearly amounts which an employee may contribute towards a 401k plan.

A 401k plan may sound like a wonderful idea if you are among the highly paid and can contribute as much as you like - but there are maximum yearly amounts which an employee may contribute towards a 401k plan. The limit to the amount you can contribute is known as the 402g limit, after that particular tax designation. In 2006 that limit is $15,000 and will probably increase by $500 during the next year. The amounts that an employee can contribute tend to be increased slightly each year, rather in the same way as wages, partly to keep up with the cost of inflation.


"If an employee contributes more than the maximum pre-tax limit to their 401k account in a specific year, the excess amount in the account must be withdrawn by April 15th of the following year" explains Paul Dlouhy, an investment analyst, who also advises on tax preparation. If you do pay excess amounts and then have to withdraw it, you will have to pay taxes and penalties.




One reason for the maximum amounts, which are determined by the IRS, are to stop very highly paid employees deferring large amounts to take advantage of the tax breaks. When the 401k was first introduced, the plan was originally aimed at highly paid executives, but it proved to be popular with workers at all pay levels, partly because it offered higher limits on contributions than the IRA. In 1986, the Tax Reform Act tightened the rules on contributions and reduced the maximum pre tax amounts that an employee could contribute to their 401k. The maximum amount allowed tends to make the 401k popular with employees at different levels of pay.

There are some exceptions to the above limits. An employee who is 50 years old or older any time during the year is now allowed additional pre-tax contributions of up to $5,000 (total contribution of $20,000) for 2006. So if you are an older person entering the workplace for the first time, you do have the opportunity to make up for missing out on participating in a retirement plan. Explains Dlouhy on the subject of additional contributions for older workers: "These additional contributions are generally known as 'catch-up' contributions and as with the regular contributions, the limit will probably increase slightly next year". You cannot make the extra contributions if you are under 50 years old.

Contributions to a 401k plan are usually taken directly from your paycheck, so after a while you tend not to notice the money that has been taken out. The amount of contributions to a 401k plan can easily be tracked and verified on your paycheck details. Of course, the amount you can comfortably afford to contribute each pay period will depend on your income and your monthly or weekly expenses.

You can also fairly easily adjust the amount of contributions if you want to, as well as exactly which investments the funds are going towards. "Generally, if you are able to, you should contribute at least enough to your 401k to guarantee a full match on your contributions by your employer, assuming they offer matching contributions" points out Dlouhy. (See question 3)

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