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401Kafe
Contributions -
Frequently Asked Questions |
How much
can I contribute to my 401(k) plan?
For 1999, the maximum pre-tax
contribution a participant can make is $10,000 – subject to the 25% of pay limitation
and special non-discrimination tests described below. The IRS imposes this limit because
Uncle Sam loses tax revenue for every dollar you contribute to your 401(k). The limit is
periodically adjusted for inflation.
The percentage of pay limit stipulates that the maximum amount that can be accumulated in
any of your tax-qualified defined contribution plans – 401(k), thrift,
profit-sharing, ESOP, and money purchase – is limited to 25% of your gross pay or
$30,000, whichever is less. Every dollar contributed (both employee and employer) counts
toward this limit.
Finally, there are special non-discrimination rules to prevent highly compensated
employees from being able to save substantially more than lower paid employees. If you
earn $80,000 per year or more, or own 5% or more of the company, additional contribution
caps may apply.
In addition to the pre-tax contributions described above, some plans also allow
participants to make after-tax contributions, which aren't included in the government
limit.
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Who decides on contribution limits?
Each company decides on
contribution limits for its own plan, within the IRS guidelines. These limits generally
fall between 1% and 20% of a participant's salary. However, setting contribution limits is
no easy task.
On one hand, the company wants to help its employees reach their retirement goals and
maximize participation in the plan. But on the other hand, the company must be sure that
its plan complies with several government-imposed limitations and non-discrimination
tests. If even one employee exceeds the government-imposed limits, or if the plan doesn't
pass the non-discrimination tests, the plan could be disqualified (meaning it would no
longer be able to accept pre-tax contributions).
Needless to say, having your plan lose its qualified status is not a good thing. Most
employers are careful and conscientious when setting plan limits.
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Is
my employer required to contribute to my 401(k) plan?
No. There is no law requiring
employers to contribute to the plan. However, many employers do choose to make
contributions because:
- it is an added incentive for employee participation.
- it is an attractive benefit and, thus, an effective tool to hire and keep top-notch
employees.
- helping to ensure that its retirees live comfortably enhances the company's image among
shareholders, customers, and current and prospective employees.
- company contributions are tax deductible.
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Is
there a rule about when my company must invest my contributions?
Yes. Your employer must invest
your 401(k) contributions no later than 15 business days after the end of month in which
the money was deducted from your paycheck.
Your employer can get an
additional 10-business day extension beyond the 15-day limit if it satisfies DOL and IRS
requirements. One such requirement is that employees must be told that their contributions
have not yet been invested. (Needless to say, this requirement alone is a deterrent for
most employers.)
Generally, most plans invest employee contributions within two to three weeks.
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If
I contribute to a 401(k) can I still contribute to an IRA?
Yes, but depending on your salary your IRA contribution may not be tax deductible.
If you contribute to a 401(k), you can deduct the maximum $2,000 annual IRA contribution
on your 1999 tax return only if you are:
- single and earn less than $31,000 per year, or
- married filing jointly, and together earn less than $51,000 per year.
You may be eligible for a partial deduction if your total income is between:
$31,000 - $41,000 for single filers, and
$51,000 - $61,000 for married filing jointly.
If you are single and earn more than $41,000 or married filing jointly and earn more
than $61,000, you can still contribute to an IRA – you just can't deduct your
contribution. On the other hand, money you contribute to an IRA still enjoys the benefit
of tax-deferred growth until you withdraw it at retirement.
Another possible option is a Roth IRA. Contributions to a Roth IRA are not tax-deductible,
but you don't have to pay taxes on any gain your investment earns – even when you
withdraw money at retirement. If your taxable income is less than $95,000 (single) or
$150,000 (married-filing-jointly) you can contribute a maximum of $2,000 per year to a
Roth IRA, even if you also participate in a 401(k) plan. If you earn more than the
$95,000/$150,000 ceiling, your maximum allowable contribution will be less than $2,000. If
you earn more than $120,000 (single) or $160,000 (married filing jointly) or if your tax
filing status is "married filing separately" and your income is more than
$10,000, you are not eligible to contribute to a Roth IRA.
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How
will my 401(k) contributions be invested?
That is up to you. When you enroll in a 401(k) plan, one of the things you have to decide
is how you want to invest your contributions. Your plan sponsor will give you a choice of
options in which you can invest. You can choose to put your entire contribution in one
option, or divide it among several.
Although there is no minimum number of investment options a plan sponsor is required to
provide, most plans have at least three choices. These often include money market funds,
corporate bond funds, growth stock funds, index funds, international funds and company
stock. The options available to you will depend on your particular plan.
Above all, you should keep in mind that planning for your retirement is a process, not an
event. 401k Forum recommends that participants rebalance their 401(k) allocations
every quarter in order to stay on track. Even if your personal or financial situation
hasn't changed, two other factors certainly will have: 1) the time you have left until
retirement will have grown shorter; and 2) if your most aggressive investments are growing
faster than the others, they will comprise a larger percentage of your account.
If you're not sure how to allocate your contributions, you're not alone. In fact, an
entire industry has grown around providing investment advice to 401(k) participants –
and 401k Forum is the first and leading provider in this area. For more information
about getting 401k Forum's service for your company, link to our Visitor Center.
If your company does not yet offer investment advice as part of its 401(k) plan, your HR
or benefits representative can most likely provide you with education materials to help
with your decision.
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What
are after-tax contributions and under what circumstances should I consider making them?
Perhaps the best way to answer
this question is to look at the following comparison between pre- and post-tax 401(k)
contributions.
Pre-Tax Contributions:
- Both the contributions you make to your account and the investment gain continue to grow
tax-free until you withdraw money from your account at retirement.
- As you take money out of your 401(k), you pay taxes only on the amount you withdraw (so
that at retirement, taxes don’t come due on your entire account balance at once).
- Because your 401(k) contribution is deducted from your compensation before taxes are
calculated, your taxable income is lower, so you pay less income tax.
- If you withdraw money from your 401(k) account before age 59 ½ you will generally have
to pay a penalty (except in cases of a qualified financial hardship as defined by the
IRS).
Post-Tax Contributions:
- Because post-tax contributions are made with money you've already paid taxes on, only
the investment's gain or income (i.e. interest and dividends) – and not your
contributions – enjoy the benefit of tax-deferred growth.
- When you withdraw post-tax 401(k) funds you only pay taxes on the gain (interest or
dividends) your investment has earned. As with pre-tax contributions, taxes are due only
when you take money out of your account.
- Post-tax contributions are not tax-deductible, so you don't get a tax break for making
them.
- Depending on your plan's rules, you may be able to withdraw your post-tax contributions
at any time without incurring a penalty. However, because the gain you earn on your
post-tax 401(k) investment is tax-deferred, you must pay income tax on that amount when
you withdraw your money. The gain is also subject to an early withdrawal penalty if
withdrawn before age 59 ½ (except in cases of a qualified financial hardship as defined
by the IRS).
Now, considering that the best tax break and the greatest opportunity for taking
advantage of tax-deferred compounding come with pre-tax 401(k) contributions, why would
anyone consider making post-tax contributions?
Here are some possible scenarios:
- If you are already making the maximum pre-tax 401(k) contribution allowed and really
want to contribute more (to get the benefit of tax-deferred investment growth).
- If your employer matches both pre-tax and post-tax contributions, and you are fully
vested for matching contributions, you might choose to maximize the employer match by
making the maximum allowable pre-tax contribution and making post-tax contributions as
well.
- If you are committed to saving money, but aren’t sure you’ll be able to leave
your money invested until retirement, you might make after-tax contributions because you
will be able to withdraw them without penalty before age 59 ½. A person considering this
idea needs to remember that the gain earned on the investment is subject to an early
withdrawal penalty if taken out before age 59 ½. Also, income tax on the investment gain
is due at the time of withdrawal.
The 401(k) is an investment vehicle for retirement. If retirement is not the goal,
there is probably a more appropriate vehicle for post-tax investment dollars.
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Is there a rule about when an employer has to deposit matching
contributions into the 401(k) account?
Each 401(k) plan has its own rules regarding the timing of employer contributions. Some
employers make contributions every pay period, while others only make them once a year.
You should check the Summary Plan Document, available from your HR or benefits
representative, to see what rules govern your plan.
Generally, employer contributions must be made within the tax-filing period for the
calendar year in question. So an employer would have until at least April 15 of any given
year to make the contribution for the previous year (or possibly longer, if the employer
files for an extension). If the employer's contributions are discretionary (linked to
company performance) they are generally deposited only after the company's performance for
the previous year is assessed.
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