As a participant in your employer’s qualified traditional 401(k) plan, you make contributions in pretax dollars, which gives you a tax break. The plan must fulfill the respective rules administered by the Internal Revenue Service to allow you this tax advantage. The IRS also oversees the amount you can put into your 401(k) yearly.
With a pretax, or traditional, 401(k) plan, you do not pay federal income tax on your contributions when the deduction is made from your paycheck. However, your contributions are subject Social Security and Medicare tax withholding, and in some cases, state and local income tax withholding. When you withdraw from the plan, you pay federal income tax, and if required, state and local taxes, on your contributions.
Pretax Contribution Limits
Pretax contribution limits might stay constant for multiple years, or they may change. In 2008, individuals under 50 could contribute up to $15,500 of their income in pretax dollars toward a traditional 401(k). However, from 2009 to 2011, the limit stayed unchanged at $16,500. In 2012, the limit was increased to $17,000. In 2013 and after, the limit will be indexed for inflation, which can increase the limits in $500 increments.
If you reach age 50 before the end of the calendar year, you can make additional pretax contributions to your 401(k). This additional amount is also called a “catch up.” In 2008, the catch up limit was $5,000. From 2009 to 2012, the limit has remained at $5,500. Therefore, in 2012, if you’re 50 or older, your limit is $22,500. However, in 2013, the limits will be indexed for inflation and might grow in $500 increments. The IRS does not require employers to include the catch-up option in its 401(k) plan, but if they choose to, eligible participants should be allowed to make the respective additional contributions.
If your employer matches up a specific portion of your pretax contributions, the matching amount is also pretax and is subject to the respective taxes when you withdraw your money from the plan. According to CNN Money, the typical match is 50 cent on the dollar up to 6 percent of your income. For example, you decide to contribute $9,000 for the year toward the plan and your employer matches 50 cents on the dollar. Your employer’s match is $4,500, which equals total annual contributions of $13,500.
Highly Compensated Employees
If you meet IRS definition of “highly compensated” employee, your contribution limits might depend on your employer’s plan participation rates. In 2012, if your annual salary exceeds $115,000, contact your employer to determine if different limits apply to you. As a highly compensated employee, the total of your pretax contributions and your employer’s match cannot exceed 125 percent of the total average that employees who are not classified as highly compensated contribute to their 401(k). If the amount exceeds the 125 percent limit, the excess amount must be reported to the IRS and is subject to taxation.
- Internal Revenue Service: Plan Participants - Limitation on Elective Deferrals
- CNN Money: Guide to Your 401k
- CBS News: Higher 401(k) Contribution Limit in 2012
- The Survivors Club: 401k Contribution Limits
- Internal Revenue Service: IRS Announces Pension Plan Limitations for 2012
- Benefit Plans: History of Maximum Pension Benefit and Contribution Limits for 2004-2012