What you need to know about 401k contributions

401k Contribution Basics

by Gary Foreman

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401k Contributions. Make the right contributions and you'll go a long way towards a comfortable retirement. Make the wrong 401k contributions and you could hamper your retirement and even get in trouble with the IRS. So let's examine everything you need to know about 401k contributions.

You're probably familiar with a 401k retirement plan. But, let's take a moment to define it anyway. A 401k is an investment plan that allows employees to contribute from their earnings. Their contribution, and any employer match, can be invested in a variety of ways and accumulate without taxes until the funds are withdrawn. The funds are managed by an administrator who acts based on the choices the employee has selected from among several investment options.

Now that we know a little about 401k basics, let's answer some common questions about 401k contributions.

How much can I contribute?

Since 2015, the maximum annual employee contribution to a 401k is $18,000. source: PensionRights.org.

There are other limits imposed on contributions from "highly compensated employees" (HCE's).

What is a highly compensated employee?

The IRS definition of a HCE can change each year. For 2017, an HCE must earn at least $120,000 a year. The IRS also uses a calculation called "annual nondiscrimination testing" that applies to HCEs.

Unless you're the business owner or executive, you won't need to worry about being a highly compensated employee. And, if you are, you should speak with a financial planner to understand what limits apply to you. The rules require computations that you'll want a professional to perform.

How much can my employer contribute?

There's no specific limit on the employer contribution. Rather, there's a limit on the total (your's and the employer's) contribution each year. For 2017, it's $54,000 (or 100% of your salary, whichever is less).

Must the employer's contribution be in cash?

No, the employer can contribute stock or cash. They may also put restrictions on its sale.

What is a catch-up contribution?

A catch-up contribution is a contribution that the employee chooses to make that's above the legal contribution limit for the 401k plan. source: IRS

Who can make a catch-up contribution?

A catch-up contribution can be made by an employee who is age 50 or older. source: IRS

Is there a maximum for a catch-up contribution?

Since 2015, the maximum annual catch-up contribution limit is $6,000 annually.source: PensionRights.org

Must I contribute from my paycheck?

Yes, contributions must be per payroll deduction. You cannot take money from another source and deposit it into the plan. However, if you do come into a windfall, check with your plan administrator. You may be able to increase your participation percentage now or at an annual update.

Must employers contribute to my 401k?

No, employers are under no obligation to contribute to your 401k plan, but nearly 80% do make some type of matching contribution.source: RetirementMadeSimpler.org

What happens if I over contribute?

An over-contribution can be corrected. Most plan administrators have software in place to prevent that from happening. Generally it occurs when someone moves from one job to another and the combined contribution is above the limit. If you do over contribute, you have until April 15th of the next year to correct the problem. Contact your plan administrator for detailed instructions on what steps to take. source: IRS

If you do not remove the excess contribution before April 15th, you'll find that the amount of the excess contribution will effectively be taxed twice.

401k contributions are not overly difficult. With the help of the plan administrator, anyone can make good decisions that will reduce taxes now and pay benefits when you retire.

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Gary Foreman

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. Gary is available for audio, video or print interviews. For more info see his media page.

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