What is a 401k contribution limit

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Given that a 401 (k) retirement plan can be an effective way to protect money from taxes, pour out and reinvest wealth as your dividends, interest, and rents without diverting a single penny to the IRS, Congress understandably has limits the amount of money you can contribute each year. Otherwise, a successful business owner, manager, actor, doctor, or musician could pour millions and billions of dollars into their 401 (k) plan each year without avoiding income taxes.

This, in turn, would result in the burden of funding placing key government services like defense and infrastructure directly on the shoulders of the lower and middle classes.

The three types of 401 (k) contribution restrictions

The downside of this otherwise sensible policy is that it can be difficult to calculate how much money to invest in 401 (k). As a result, you must be extremely careful not to exceed the 401 (k) contribution limits in any given year. What makes the limits a little more complicated than those on a traditional IRA or Roth IRA is the fact that, for all intents and purposes, there are three different types of limits that are applied to your 401 (k) contributions.

The election advance 401 (k) contribution limit
  • represents the amount of money the 401 (k) account holder can contribute from their own paycheck. In 2012, that portion of the 401 (k) limit was set at $ 17,000. In the years to come, it will increase in increments of $ 500 based on changes in the rate of inflation. Â The containment limit 401 (k) Contribution Limit
  • represents additional money that employees over the age of 50 can contribute to their retirement savings. As of 2012, that number stands at $ 5,500.
Additional 401 (k) contribution limits
  • represent a "catch all" rule. In principle, the total of all election contributions plus catch-up contributions plus the monies added to the account by the employer in suitable funds or bonus systems etc. must not exceed the smaller amount of 100% of your compensation or USD 50. 000 in 2012. For this calculation, the income is capped at $ 250,000 for 2012. The last bit is important. Essentially, this means that the most money you can invest in a 401 (k) in any year is $ 50,000. Of that, only $ 17,000 can come from you saving out of your pocket on your own salary deductions. .. Â If you are 50 or older, you can add another $ 5,500 to that amount (or $ 22,500 total). The other $ 33,000 or $ 27,500, depending on your age and whether or not you qualify for the make-up contribution, must come from your employer. Very few employers offer 401 (k) packages generously enough to accommodate these types of Use limits.

Best case scenario, if you're a self-employed business owner who only works with your spouse, it might be possible to create a 401 (k) plan that is structured so that your family can set aside $ 100,000 a year . in tax-privileged accommodations. In a long career of 30 or 40 years, the wealth you would build could very easily reach tens of millions.

What happens if you exceed the 401 (k) contribution limits during the year?

If you add more funds to your 401 (k) account than you are allowed to, you have until April 15th to report the plan to return the funds to you. This overpayment is referred to an excessive deferral.

If you received a tax deduction, you must return it after the overtime is lifted. However, they should not be subject to the additional 10% early repayment penalty. Â

It is your responsibility to receive more than 401 (k) contributions, not your employer's. Â If you don't remove the deductible before the tax return expires in the year the mistake was made, you will face severe penalties, some form of double taxation, and your entire retirement system may become ineligible. That would have huge financial implications if you built a decent sized nest egg.

The 401 (k) contribution limits may be different for highly paid employees

If you are qualified as what is known as a highly paid employee, i.e. making more than € 115,000 from your employer in 2012, you may have a lower 401 (k) limit than you would otherwise.

The reason? Congress wanted to ensure that 401 (k) plans weren't just used to benefit higher positions in the management structure. As a result, the total percentage of 401 (k) assets held by highly paid employees cannot exceed certain thresholds (technically, the total 401 (k) savings from highly paid employees cannot exceed 125% of the average deferment percentage. Ineligible staff in one calendar year). Â

In other words, you may face lower contribution limits because the other employees in your company haven't saved as much money as they should have saved. It's unfortunate, but that's how the rules are written.

Talk to a retirement specialist, tax advisor, qualified accountant, and / or human resources department if you have any questions

The rules and regulations associated with retirement plans are notoriously complex. If you make a mistake, it can seriously affect your family's finances. If you think you did something wrong or are at risk of breaking any of the rules that govern your retirement plan, speak to the right people and have the problem resolved as soon as possible.