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A Guide to 401(k) Contribution Limits

In a flush year, it can be tempting to squirrel away funds for retirement, and the obvious benefit of 401(k) contributions is that they’re tax-exempt.  However, there are strict guidelines for how much you can put in over how much time.  Let’s consider how those rules might apply to you, and what you can gain from following them wisely.

How They Work

The annual limit for 401(k) contributions – also known as the 402(g) limit – varies from year to year according to tax policy and inflation.  For 2011, the limit was $16,500; it’s been raised to $17,000 for 2012.  It’s likely to be increased by $500 a year for the foreseeable future.  And if you’re over 50, you’re entitled to make “catch-up” contributions of up to $5,500 a year.

Benefits

Over time, making the maximum possible contributions to your 401(k) will turn out to be a sound financial decision.  It may hurt to live a bit below your maximum standard of living, but having a safe, developing, non-taxable nest egg puts you in the best possible position when you decide to retire.

Pitfalls

It’s very important not to exceed these limits, so it’s a good idea to keep a careful eye on them near the end of the year, and to be certain any errors are corrected by the April 15^th filing date.  Stiff penalties can be incurred if you mistakenly contribute too much over the course of a fiscal year.

Such mistakes usually happen when you change jobs mid-year and the new employer doesn’t carry over the contributions properly.  Remember, you’re responsible for your tax return, so double-check the paperwork if you’ve had a recent job change.

Keep in mind that these contribution limits only apply to the employee – not the employer.  The employer has a much higher limit applied when committing to the employee’s 401(k) plan – $49,000 in 2011, plus catch-up contributions if the worker is over 50.  A good benefits package should include a generous matching percentage of your own payments.  If your company doesn’t offer such incentives, it may be a good idea to lobby management, or find one that does.

Conclusion

Knowing and meeting your 401(k) contribution limits are important elements of financial security, so be sure to stay on top of the guidelines.  Come retirement, you’ll be glad you did.