Photo Credit: Jacob Wackerhausen/iStock

Text Size:

The amount of money you can contribute, tax-deferred, to your 401K plan is linked to inflation and so the precise amount changes each year. It is also linked to your age. If you are aged 49 years or less you have more restrictions on the amount you can contribute to your 401K than do people who have celebrated their 50th birthday. 

Let’s Break It Down

In 2009 an employee is allowed to contribute $16,500 to his or her 401K. In 2010 the amount could go up, based on inflation. But if you turn 50 in 2009 you can contribute an extra $5,500 for a total of $22,000. In 2010 persons age 50 or older may be able to contribute even more, depending on the effects of inflation.

At the same time that working individuals are contributing to their future retirement, employers can also contribute. Employers may contribute as much as 6 percent of a workers gross pre-tax compensation.  For example, if a worker receives $100,000 a year in compensation, the employer may contribute as much as $6,000 to that employee’s 401K plan.

That would cap the 2009 total permissible tax-deferred contribution for a worker 49 years of age or less – with a gross annual compensation of $100,000 – to $22,500 and a worker 50 or older to a maximum contribution of $28,000.

If You Are a “Highly Compensated Employee” Contribution Limits Can Be Trickier

Employees who make more than $110,000 in a calendar year may be subject to special rules and special limits to the contributions that they and their employer can make to their 401K plan. Under current rules, a Highly Compensated Employee and their employer can contribute no more than 125 percent of the average amount that non Highly Compensated Employees at the same company contribute to their 401Ks.

However, there's a significant twist.  A Highly Compensated Employee can contribute more than 125 percent of the average contributions of non Highly Compensated Employees, but anything above the 125 percent threshold must be declared to the IRS and taxes must be paid on that portion of the contribution.

Contributing More To Your 401K

The contribution limits cited earlier in this article only apply to tax-deferred contributions. Workers are allowed to contribute more to their 401Ks, but additional contributions are not tax-deferred.  Even taxable contributions have their limits.  In 2009 the maximum contribution that can be made, both tax-deferred and non tax-deferred, cannot exceed $49,000.

This amount is subject to inflation indexing and could rise in coming years based on inflation.

Withdrawing Funds

There are strict withdrawal provisions for 401K accounts. Persons withdrawing funds prior to reaching 59 ½ years of age have to pay a 10 percent early withdrawal penalty plus have 20 percent of their withdrawal withheld for possible income purposes. These rules do not apply, however, to any contributions made to the account which were above prescribed limits and which were taxed in the year in which the contribution was made. Any “extra” contributions that were made with fully-taxed money can be withdrawn at any time with no penalty and no withholding. Bear in mind that if you choose to withdraw the interest earned on those excess contributions then that money is subject to penalties and withholding.

Get Expert Advice

Your 401K is probably one of the largest portions of your retirement package, so it only makes sense for you to consult a professional who is knowledgeable and highly skilled in setting up 401K plans so that when it comes time for you to retire there won’t be any surprises and no regrets.

TSC Sources & Recommended Resources

• 401K Contribution Limits & “Catch Up” Provisions
• Rules For 401K Contributions
• A Look At a Typical 401K Retirement Plan

Comments / Post a comment