Your employer-sponsored 401k plan allows you to save money for retirement through payroll withdrawals, making saving automatic. Your contributions are tax-deductible. You pay taxes on the money as you withdraw it from the account upon your retirement. The Internal Revenue Service restricts the amount you can contribute to your 401k. Your income doesn't have to be more than the amount you contribute, but it must at least equal the amount.
Who Can Contribute
You can contribute to a 401k if your employer establishes one and you earn wages. Your employer withholds an amount you designate from your paycheck and forwards this amount to the financial institution that manages the 401k. If you don't earn wages, you can't make a contribution. For instance, if you take a sabbatical for a year, you're technically still an employee of the company, but you can't make any new 401k contributions until you begin receiving a paycheck again.
The IRS sets a maximum amount you may contribute to a 401k plan each year. For 2010 and 2011 this maximum is $16,500 a year for anyone under 50 years of age. You need to earn at least $16,500 in wages in order to contribute this maximum. If you're more than 50 years old, you can make an additional catch-up contribution of $5,500, as of 2010 and 2011, provided your plan allows for such catch-up contributions. Your wages must equal the amount of regular and catch-up contributions, but don't have to be more than this amount.
Your employer can set some rules regarding its 401k plan. For instance, federal law doesn't require your employer to permit catch-up contributions. Your employer may choose to match all or part of your contributions. Your employer may require every employee to contribute a certain percentage of their income to the retirement plan, although you have the option to change that percentage or opt out of making contributions altogether.
If you work for more than one employer and are eligible to participate in a 401k or other retirement plan with each employer, all your contributions added together can't exceed the maximum contributions as mandated by the 401k. It's up to you to keep track of your contributions and make certain you don't exceed the maximums. If you determine you've contributed too much, you can request a refund without penalty, as long as you do so prior to April 15 of the following year.
- Hemera Technologies/AbleStock.com/Getty Images