401k Plan Contribution Limits
- Congress originally created the 401k plan in 1978, when they added a section to the Internal Revenue Code that allows employees to defer income taxes on income they defer rather than take directly. The law became effective in 1980, and the plan proved to be extremely popular: More than half of large firms offered 401k salary deferral programs within three years. Some organizations, including the Pension Rights Center, have criticized the growth of 401k programs, arguing that they undercut the strength of traditional pension plans.
- From the employer's point of view, a generous 401k plan, with a competitive company match, can be an important part of an employee benefit package. From employees' point of view, the 401k plan allows them to save larger amounts for retirement on a tax-advantaged basis than they could from an Individual Retirement Arrangement (IRA) or Roth IRA alone. 401k plans also provide a degree of protection against the claims of creditors, as the law exempts reasonable retirement accounts from being awarded to them in judgments.
- 401k plans come in different forms: Roth 401ks are funded with after-tax dollars, but compound tax-free and allow for tax-free withdrawals once you reach age 59 1/2. "Safe harbor" 401ks are participant-directed 401ks (in which plan participants direct the investment of their funds). With trustee-directed 401ks, the employer appoints an investment manager to oversee employee contributions.
- As of 2010, the maximum employee contribution limit was $16,500. Contribution limits in future years will be indexed for inflation. Employees over age 50, however, can make "catch-up" contributions of up to $5,500 each, in addition to the standard contribution limit. If you accidentally contribute too much, you must withdraw the excess by April 15 of the next year.
- Congress was concerned about corporations not extending the benefits of salary deferral and matching contributions to their lower-paid, rank-and-file employees, and imposed strict anti-discrimination clauses limiting the ability of highly compensated employees (HCEs) to contribute unless workers participated in the plans. Known as "top-hat" provisions, the rules define highly compensated employees as those who earn more than $100,000 or own more than 5 percent of the company. The average deferral percentage of HCE contributions may not exceed the lesser of the rank-and-file deferral percentage plus 2 percent, or 150 percent of rank-and-file workers' deferrals. However, plan sponsors can exempt themselves if they adopt the "safe harbor" provisions, such as matching employee contributions and providing immediate 100-percent vesting.
