401k Contribution Limits: How Much Can You Put In Your 401k?

Most employees in the United States have the benefit of having their retirement fund in a structured fund maintained by their employers for them. Under the 401k provision of the tax code, employers are required to establish a 401k program in which their workers can save a portion of their earnings in their 401k account so they can build funds for their successful retirement. These 401k programs work by allowing employees to invest in various instruments to grow their retirement fund. At other companies, there is an employer contribution equal to what the employee chooses to contribute to their 401k account. Such contributions are not made on a pre-tax income basis where taxes are not deducted in the year in which the contributions are made. Taxes are deferred on the money contributed as well as its earnings when the retirement fund is withdrawn in later years.

The 401k provision of the Internal Revenue Code provides certain limitations on the amount an employee can contribute to their 401k account. Total 401k contribution limits also apply to employer matching contributions. Generally, the total amount of the contribution should not exceed the total amount of compensation the employee receives. The 401k contribution limits increase each year from $45,000 in 2007 to $46,000 and $49,000 in 2008 and 2009 respectively. After 2009, the limits on total contributions to 401k accounts will increase in $1,000 increments based on inflation. Excess contributions by an employee to a 401k account will result in the employer receiving penalties for tax code violations. These excess contributions will be labeled “non-qualified” and cannot be withheld in the 401k retirement account.

High-salary employees are also subject to 401k contribution limits. Additionally, to ensure that the majority of employees benefit from this program, there is a limit to the number of highly compensated employees who can contribute to the total company-wide group contribution. Highly Compensated Employees (HCEs) are defined as those earning $100,000 in annual revenue in 2007. Some companies also define these HCEs as the top 20% of their workforce ranked based on the amount of salaries they receive . Those who own at least 5% of the company’s property are also classified as HCE. No more than 2% of the annual deferral percentage must come from these HCEs unless they are disqualified from participating in the program.

Also within the 401k contribution limits are provisions for seniors who wish to make catch-up contributions to their 401k accounts. Employees who are age 50 or older may make additional contributions of $5,000 in 2008. This year, the catch-up contribution limit for these older employees was increased to $5,500. These limits are in addition to the regular contribution limits for all 401k participants, which are set at $15,500 from 2007 to 2008. This year, the contribution limit was increased to $16,500.