In a Nutshell: Understanding 401(k) Contribution Limits and Tax Advantages

In a nutshell, a 401(k) retirement savings plan is a powerful tool to help you save for your future in a tax-advantaged way. However, it’s crucial to avoid overcontributing to your account. The IRS sets maximum contribution limits for employees and employers, and exceeding these limits can result in double taxation on the extra amount. Contributions to traditional 401(k)s are tax-deferred, meaning you won’t pay taxes on the money you put into the account until you withdraw it in retirement.

How does a 401(k) contribution work? Employees can contribute a percentage of their paycheck to a 401(k) plan offered by their employer. Contributions to traditional 401(k)s are tax-deferred, while Roth 401(k)s are made with after-tax dollars. Employers may also match employee contributions up to a certain limit. While it’s possible to access the money in your 401(k) early, you may face a 10% early withdrawal penalty.

How much should you contribute to your 401(k)? It’s recommended to contribute at least enough to get your employer’s full match. Fidelity Investments suggests saving up to 15% of your pretax income for retirement, including employer contributions. Automatic annual contribution increases are also available in many 401(k) accounts.

What is the basic contribution limit for 401(k)s? In 2024, employees can contribute up to $23,000 to their plans, with an additional catch-up contribution of $7,500 for those age 50 or older. Excess contributions may be subject to double taxation and the 10% early withdrawal penalty if not corrected in a timely manner.

Employer matching contributions are common, with employers offering to match employee contributions up to a certain limit. The combined maximum contribution limit for employees and employers in 2024 is $69,000 (or $76,500 for those age 50 or older). Vesting periods may apply, so it’s essential to understand your plan’s requirements.

What are the tax advantages of maxing out a 401(k)? Maxing out your 401(k) can lower your tax bill by deducting contributions from your taxable income. Additionally, your money grows tax-deferred until retirement, leading to potentially higher returns.

401(k) contribution mistakes to avoid include not contributing, missing out on employer matches, contributing too much, forgetting about your 401(k) when leaving a company, and not designating beneficiaries. It’s crucial to stay informed and make the most of your 401(k) to secure a comfortable retirement.