Why Everyone Should Meet 401(k) Contribution Limits

401(k)s are a type of retirement account for employees of private companies in the U.S. that get their name from subsection 401(k) of the U.S. tax code. They are now the main form of retirement savings for employees and will likely only become more important as time goes on. To take full advantage of the tax savings allowed by the government, employees who are financially able should think about maxing out their 401(k)s by contributing up to the 401(k) contribution limit in 2014. Read on to find out more.

401(k) contribution limits
Similar to individual retirement accounts, 401(k)s allow your investments to grow tax-free toward retirement. With regular 401k(s) you get an income tax break up front and then pay income tax when you withdraw. With Roth 401(k)s, you pay income taxes up front and then withdraw your money tax-free in retirement. In both cases, once you contribute, there is a 10% early-withdrawal penalty if you withdraw funds before reaching age 59.5, though there are a few exceptions for those going through hardships. You can read more about the exceptions on the IRS' website.

401(k)s differ from IRAs in some key ways:

  1. 401(k)s can only be made available through an employer.
  2. Employers can contribute to employees' plans.
  3. There is no maximum income level for Roth 401(k)s.
  4. Employees can contribute much more per year to 401(k)s than they can to IRAs. How much more?

Maximum IRA contribution

$5,500 (or $6,500 for individuals age 50 or older)

Maximum employee 401(k) contribution

$17,500

Maximum combined contribution for employee and employer

$52,000

Source: IRS.

401(k)s allow individuals to contribute more than three times as much as IRAs. And with many employers offering matching 401(k) contributions, the combined contribution limit is nearly 10 times that of an IRA.

Important point on employer matching
It is important to note that you have to read the fine print on how employers match retirement contributions. While many will match contributions as a percentage of salary, the exact way they do this varies and can have major consequences. Many employers have vesting requirements, meaning that you must have worked at the company for a certain number of years before you can receive the matching contributions. Others will only match your salary as a percentage of each paycheck, so you miss out on a lot of money if you contribute to your 401(k) as a lump sum.

Bottom line
Regularly contributing to a 401(k) is a great way to grow your investments for retirement. The more you contribute, the more your assets can compound over time, so if possible, you should strongly consider maxing out your 401(k) contribution.

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Read/Post Comments (3) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 19, 2014, at 7:16 PM, Lucaskasan wrote:

    Given that study after study has documented the poor quality and high hidden fees of most 401(k)s, if there is no employer match (an apparently unthinkable, though not uncommon, prospect in most of these articles), should you still contribute?

  • Report this Comment On May 20, 2014, at 9:21 AM, TMFDanDzombak wrote:

    @Lucaskasan I believe "most" is a bit of a stretch. Every person's situation is different so that is a choice you will have to make on your own.

    To find out if your 401k is high cost compared to others, check out brightscope.com

  • Report this Comment On May 20, 2014, at 9:57 AM, Lucaskasan wrote:

    Which "most" are you referring to, the one regarding the overall quality of 401(k)s or the one regarding the assumption within most articles that the employer is matching? As far as the first goes, I stand by the studies (like this one http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2399531) and my own observations of many 401(k)s. Far too many plan offer funds whose main attribute is that the fund is paying the plan manager for inclusion in the plan. The contributor is also paying the fund manager for pretty much nothing.

    As far as the second, do you deny that most articles fail to consider the possibility that the employer does not match?

    Also, it is not clear whether cost should be evaluated in terms of comparison to other plans, or whether, as other Fools have pointed out, nearly all plans cost much more than the work of the financial manager of the plan merits, and fail to deliver returns in excess of a simple index fund.

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