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:
- 401(k)s can only be made available through an employer.
- Employers can contribute to employees' plans.
- There is no maximum income level for Roth 401(k)s.
- 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.
