Saving for retirement is important for many workers. The goal of living comfortably during the golden years means planning, saving and even making some sacrifices today. For many, a 401(k) is the key to retirement. But how much can you save in it?
Every year, the Internal Revenue Service (IRS) announces the contribution limits for 401(k) plans. For 2011, the limits are the same as 2010's.
What Are 401(k) Plans?
A 401(k) plan is a type of a retirement saving plan. The title "401(k)" refers to a section of the federal tax code that allows workers to save for retirement by investing in mutual funds, annuities, stocks and more.
There are many benefits to 401(k)'s, such as:
- Interest earned on your investments are tax-deferred until the money is withdrawn at retirement
- Your contributions lower your taxable income because they're taken out of your paycheck before other taxes, like payroll taxes
- Many employers match part or all of each employee's contributions - it free money
2011 Contribution Rules
Contributing to a 401(k) plan gives you tax benefits. However, there are limits and rules to the amount you can contribute.
The maximum amount you can contribute each year is the lower of either:
- The maximum percentage contribution limit set by your employer's plan, or
- A dollar limit set by the IRS
For example, in 2011 (like 2010), the most you can contribute is $16,500. However, say your employer's plan lets you contribute up to 10 percent of your salary. If you make $50,000 per year and contribute the 10 percent maximum, the most you can stash away in your 401(k) is $5,000.
The maximum contribution limit usually increases each year based on the consumer price index (CPI) of the previous year. In 2008, the maximum limit was $15,500. Since then, it's stayed unchanged at $16,500.
Employer matches or adds any contribution to your 401(k) plan aren't counted towards 401(k) contribution limits.
Catch-Up 401(k) Contributions
Some employers let workers who are at least 50 years old make catch-up 401(k) contributions. Those are on top of your regular 401(k) contributions. The amount you may contribute is limited, and, like other contributions, the limit may go up from year to year. The catch-up contribution for 2011 is capped at $5,500 - the same as 2010.
Did You Contribute Too Much?
Accidents happen, and your contributions for the year may go over the limits set by the IRS or the 401(k) plan. Contact the investment firm that manages the 401(k) - it's probably called the plan administrator. Ask that the excess contribution be sent to you.
Of course, you'll have to include that amount as income on your tax return for the year the extra contribution was made.
Make sure you call the administrator before April 15. If you don't, there are serious consequences:
- The excess contribution will be taxed as of the date the contribution was made - you lose the tax deferred benefit
- The excess contribution will be taxed a second time when it's paid to you at retirement - it's taxed twice!
- The IRS may determine that the retirement plan isn't in fact a qualified plan, which means you could have to pay taxes on all contributions immediately
Plan & Act
Saving for retirement is always a good idea. However, even these savings are impacted by a bad economy. It's best to be smart with your savings and continue to save through the bad times.
As much as your budget allows, try to save to the maximum amount set by the plan or the IRS. Try to increase your contributions when and if the limits increase in 2012.
If you have questions about savings, contact your bank and speak with a financial consultant who can help you learn to budget and save. Be sure to talk with your plan administrator about additional investment options as well.
Questions for Your Attorney
- I'm nearing retirement age. Can you help me review my 401(K) accounts and review my tax, retirement and estate plans with respect to taxes?
- Recently, it seems to have been a perfect storm with losses to my retirement accounts and other financial crises, such as job loss. Can you help me review my taxes before year's end, and advise me as to any changes I should make for the upcoming year?
- I lost my job recently; can you review my severance package documents and plans for my 401(K) account?