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 If your employer offers you a 401k plan, then consider yourself lucky. These plans are a great way to fund your retirement. But sometimes the 401k contribution limits can get a little confusing because there are employee matches and before-tax and after-tax limits. Are you confused yet?
Then there is also something called a catch-up contribution. If you're age 50 or older in 2005, then you're eligible for this type of contribution. Wait just a minute, let's start all over. In this article we're going to concentrate on the contribution rules that apply to 401k plans. From employer-to-employee we'll straighten you out on all the details of the 401k contribution limits.
Contribution Limits for 2005
In general, there are a total of four types of contribution limits that apply to 401k plans. The first has to do with pre-tax contributions, the second with catch-up contributions, the third with employer contributions, and the forth with total contributions. Let's break all these categories down into specific sections to make this a little bit cleaner.
Pre-Tax Contributions
The total pre-tax contribution that an employer can make to their 401k plan in 2005 is $14,000. In 2006, the pre tax contribution moves up to $15,000. For the years 2007 and beyond, the IRS can move up these limits up in step with a cost of living index. The limit in 2007 was $15,500, and it remained at that level in 2008. In 2009 and 2010, the contribution limit was $16,500.
Catch-Up Contributions
If you are age 50 or older in the calendar year 2005, then you can make an additional pre-tax contribution to your 401k plan. In 2005, that catch-up contribution is $4,000. In 2006, the catch-up contribution is $5,000. Right now the plans are to also increase the catch up contribution in 2007 and beyond using a cost of living index. So if you're eligible for a catch up contribution in 2005, then you - the employee - can put $14,000 plus $4,000 or $18,000 into your plan. But there is more.
Employer Contributions
Many 401k plans offer employer matches or funding to help increase participation in the program. The contribution limit for employers is set at 6% of the employee's pre-tax compensation. We'll talk about one possible exception later on when we talk about highly-compensated employees.
So if you're total compensation is $100,000 you can contribute $14,000 pre-tax and your employer can contribute another $6,000 for a total of $20,000. If you're 50 or older, then you can contribute another $4,000 pre-tax bringing the total to $24,000.
Total Contribution Limits
Total contributions to a 401k plan include both pre-tax and after tax contributions made by the employee in addition to pre-tax contributions made by the employer. In 2005, the total contribution limit to a 401k plan is limited to the lesser of $42,000 or 25% of your total compensation.
If we continue with the above example, we've already contributed $24,000 with pre-tax money and employer contributions. If you're total compensation is $100,000, then that means you can contribute another $1,000 on an after tax basis to bring your total contribution to $25,000 or the 25% limit.
Highly-Compensated Employees
If you make over $90,000, then you may be subject to a restriction that applies only to highly-compensated employees. This rule is in place because the government wants to make sure that the benefits of a 401k plan flow to all employees - not just the highly compensated ones.
Each year the IRS conducts a test of an employer's plan to make sure they've got active participation beyond their highly compensated folks. Quite frankly, this is one of several reasons that many employers offer matching contributions. If a company is not achieving their participation goals, then the contributions made by highly-compensated employees may be restricted.
The only way to find out if this applies to your company is to contact you 401k plan administrator. Otherwise, the same contribution rules that apply to the rank-and-file employees apply to highly-compensated ones.
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