If your employer sponsors a 401k plan, you have the ability to fund the account with elective salary deferrals. A 401k account grows tax-deferred, allowing you to save more for retirement. However, there are limits to the amount that you can contribute to your 401k.
You can continue to participate in your 401k plan while still employed by your current employer. The Internal Revenue Service imposes no maximum limit on the amount that you can contribute to a 401k as a whole, but it does impose annual contribution limits. As of 2011, you can contribute up to $16,500 although your contributions are made from salary deductions so your contribution cannot exceed your annual wages. The IRS can adjust contribution limits whenever the cost of living changes, as recorded in the Consumer Price Index.
From a federal tax perspective, you reach retirement age at 59 1/2, after which you can withdraw funds from your 401k without incurring the 10 percent premature withdrawal penalty. To enable people who are nearing retirement age to bolster their nest eggs, the IRS allows workers age 50 and older to make catch-up contributions in addition to the maximum annual contributions. As of 2011, the IRS limits catch-up contributions to $5,500. Your total contribution cannot exceed your annual wages.
Under federal tax rules, companies with no more than 100 employees can sponsor low-cost pension plans known as a SIMPLE 401k. These work similarly to regular 401k plans except the annual contribution limits are lower. As of 2011, people under 50 can contribute up to $11,500 to their SIMPLE 401k. Older employees can deposit the same sum as well as catch-up contributions that cannot exceed $2,500. On a SIMPLE 401k plan, your employer can make a matching contribution of up to 3 percent of your salary, while employers can make matching contributions of up to 6 percent of your salary on regular 401k plans.
Highly Compensated Employees
As of 2011, if you earn an annual salary of more than $110,000, or you own more than 5 percent of the company that you work for, then you meet the IRS' definition of a Highly Compensated Employee. Federal law limits the contributions that HCE's can make to 401k plans. Restrictions on HCE contributions prevent highly paid employees from benefiting from 401k tax deferrals more than lower paid employees by contributing a higher percentage of their salaries to the account.
Your 401k plan operator can use one of two methods to calculate your maximum contribution to the plan. Using the first method, your contribution cannot exceed 125 percent of the amount that the average non-HCE contributes. If average contributions to the 401k plan by other employees amount to 1 percent, then your contribution cannot exceed 1.25 percent of your salary. Alternatively, HCEs can contribute no more than twice the sum that that non-HCEs contribute as a percentage of their salary, although contributions for HCEs cannot exceed the average non-HCEs contribution by more than 2 percent. Using method two, if other employees contribute 5 percent on average, you can only contribute 7 percent because doubling 5 percent would cause you to deposit more than 2 percent more than the other employees.
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