There are two main ways for Americans to save for retirement: IRAs and 401(k) plans. The contribution limits for IRAs are pretty straightforward. Basically, you can contribute $5,500 for the 2014 tax year unless you're 50 or older, in which case you can contribute an extra $1,000.
However, the 401(k) limits are a little less straightforward. The IRS code regarding your 401(k) limits 2014 contributions, but the rules are more complex than those governing IRAs. There are other factors to consider, such as employer contributions.
How much can you contribute from your paychecks?
For traditional 401(k) plans, you can elect to defer up to $17,500 during the 2014 tax year. This doesn't include any matching funds contributed by your employer -- just the money you choose to have withheld from your paycheck and deposited into your 401(k). It also doesn't include any mandatory (i.e., non-elective) deferrals. For example, if your company requires 401(k) contributions of 3% of your salary, you can contribute $17,500 beyond that amount.
If you are 50 years old or more, the rules allow for a "catch-up" contribution amount of $5,500 added to the normal limits. So, if you're over 50, you can choose to defer up to $23,000 to your 401(k) plan. These limits will likely be increased in future years to compensate for increases in the cost of living.
It is also worth noting that even though it's called a "catch-up" contribution, you don't need to be behind in your retirement savings in order to take advantage of it. Anyone who meets the age requirement is eligible.
What about the "employer match"?
The IRS has a generous 401(k) contribution limit for the total annual contribution. For 2014, up to $52,000 ($57,500 if over 50) in total can be contributed, and this figure includes elective contributions, mandatory contributions, and employer matches.
The figure does seem rather high, but there are some employers with very generous matches, especially to their longest-serving employees. For example, a local health care company in my city matches 50% of contributions for new employees, and this increases incrementally to a 200% match after 20 years of service.
Unlike an IRA, a 401(k) does not exclude anyone based on their income; everyone is eligible to have a portion of their salary deferred into a 401(k), regardless of income.
However, there are limits to the amount of income employers can take into account for matching purposes. For high-income individuals -- which, for 401(k) purposes, means those who will earn more than $260,000 for the 2014 tax year -- any income above that amount cannot be considered for a matching plan.
For instance, let's say an employee (who is under 50) earns $400,000 per year and elects to defer the maximum amount of $17,500. And let's say the employer will match 50% of an employee's contribution on up to 5% of their compensation. Because of the income limitation, the employer can only match up to 5% of $260,000, or $13,000. So, in this case, the employer match would be $6,500, not 50% of the full $17,500 contributed.
What to do if you want to contribute more
If you want to set aside more for your retirement than the 401(k) limits for 2014 allow, there are ways to do it. First, you can max out your IRA contributions for the year; the limit currently stands at $5,500 ($6,500 if you're over 50). You have two choices -- traditional or Roth -- and you can choose whichever works best for your tax preferences and income level.
If you still want to set aside extra money, a traditional brokerage account may be a good option, and you can do some portfolio allocation to lessen the tax burden. For instance, you high-dividend investments should be mainly held in tax-advantaged accounts, but growth stocks that pay little or no dividend make sense to buy-and-hold in a taxable account. You won't owe any taxes on any share price appreciation until you sell, and your income investments will be compounding tax-free in your IRA.
The matching is free money. Take it!
The best thing you can do with your 401(k) is to take full advantage of your employer's matching program by contributing the maximum amount of your salary that they'll match (or that the IRS will allow). If you are eligible to contribute more than your employer will match, you can choose whether or not to take advantage of the full 401(k) contribution limit. However, at the very least, you should be taking advantage of the free money being offered to you.
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