The most viable and lucrative individual retirement account program available to today’s employees is the 401k plan, but to participate in this plan it’s very important that you understand the 401k contribution limits. Here we will discuss those limits in a bit more detail, including a brief outline regarding catch-up limits, pre-tax limits and the matching contribution limits for employers.
What Is Meant By 401k Contribution Limits?
The structure of a 401k retirement plan is fairly simple. Each month, employees can elect to have a certain portion of their income deposited into one of these plans, and the amount deposited is usually matched by the employee’s hiring company. This is a great way to save for retirement—savings above and beyond the standard contributions to Social Security or an employee’s pension—and perhaps the most attractive feature of these plans is that the initial income deposited into a 401k plan is not taxed. However, there is a catch. Only so much money each month can be deposited into these accounts, an amount also referred to as 401k contribution limits.
Current Trends in 401k Contribution Limits
Contribution limits to a 401k plan are largely determined by inflation and cost of living, and since the economy has struggled in recent years, the amount of contributions allowed has risen very slowly—so slowly, in fact, that many investors were beginning to seek other alternatives for their retirement savings. Fortunately, though, recent trends have shown that the 401k retirement plan is back into the picture as one of the most trusted and lucrative ways for Americans to save. Below is a brief snapshot of the annual pre-tax limits for the past four years, as well as the projected limits through 2012:
2012- $16,500—plus $500 incremental raises based on an index that takes into account any cost of living increases
What Are 401k “Catch-Up” Contribution Limits
For those individuals over the age of 50 who started a bit late in 401k investing, there is a provision in the 401k plan that allows you to make “catch-up” contributions to your plan. These pre-tax catch-up contributions also have limits, here's the 401k contribution limit for 2012:
2012- $5,500 plus an index for inflation in $500 increments
Just as the standard contribution has been indexed for inflation in 2012, so too have the catch-up limits.
What about Employer’s Contributions?
Currently, the limit imposed on matching employer’s contributions to an employee’s 401k plan is set at 6% of the employee’s salary. What this means for 2012 is that an employee earning $100,000 annually can invest a pre-tax amount of up to $16,500 of their own money, while the company he/she works for can invest an additional $6,000, bringing the total 401k contribution threshold up to $22,500, plus an indext for inflation in $500 increments.
Investing in a 401k plan helps individuals save money for retirement without being taxed for those investments, but because there are 401k contribution limits, many will elect to make additional “after-tax” deposits as well. These plans are normally regarded as the safest type of retirement accounts, with the most pre, and after tax benefits for plan participants.