The Deductions for Contributing to a 401(k)

by Herb Kirchhoff

Employees who participate in an employer-sponsored 401k tax-deferred retirement savings plan get the growth benefits of contributions made by their employer. They also get a tax deferral on all investment gains made under the 401k plan, and a tax deduction on the contributions they put into the plan. However, there are some limits on your deductible 401k contributions.

Tax Deductions

You can elect to have a portion of each paycheck deposited in your 401k account via payroll deduction. Income taxes on that money will be deferred until you withdraw the funds from the plan. But you must still pay Social Security, Medicare and unemployment taxes on your 401k contribution amount. As of 2011, you can’t deduct from your income more than $16,500 a year in 401k contributions you made. Your employer’s 401k plan has the option of setting a lower limit on your contributions, for instance to meet federal nondiscrimination requirements. Your employer may also contribute to your 401k, but you get no tax deduction for those contributions.

Catch-Up Contributions

If you are over age 50, your employer’s 401k plan may allow you to make additional tax-deductible catch-up contributions of up to $5,500 per year. If you are over 50 and participate in the 401k plans of two unrelated employers, you can make deductible catch-up contributions to both plans regardless of whether the plans have catch-up provisions. But your total catch-up contributions to both plans can’t exceed $5,500. However, an employer is not required to provide for catch-up contributions in any of its plans, so check to see if your employer does.

Contribution Limits

The sum total of all employer and employee contributions to your 401k account can’t exceed the lesser of $49,000 or your total wages for the year. If you ended up contributing more to your 401k than the allowed limit, you must notify the plan administrator to refund the excess to you. If you act before the due date of the current year’s tax return, the excess contribution is taxed as ordinary income. There is no 10 percent early withdrawal penalty on such a corrective withdrawal. The corrective distribution is reported to you on a Form 1099-R. If you leave the excess in the 401k, it will still be taxable in the current year and will be taxed again when you withdraw it at retirement.

Automatic Enrollment

Some employers’ 401k plans feature automatic enrollment of new employees. This feature allows the employer to automatically deduct a fixed dollar amount or percentage from each paycheck and deposit the money in a 401k account. You have the option to refuse automatic 401k payroll deductions or to have a different amount deducted from each pay. Automatic payroll deductions by your employer are a deductible contribution to your 401k plan.

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