401K Plans Are An Excellent Choice For Accumuation Of Wealth
401K plans are an essential part of personal financial planning. They have become a popular choice for employers who want to offer a retirement plans to their employees. These plans often have a combination of salary deferral with company matching, and some profit sharing from the employer. However, as recently as 2008, many employers have announced that they will no longer be making matching contributions for their employees. All things considered, this is better than them having to cut jobs, and I still think that 401K plans are a good thing to participate in. The majority of the money that goes into a 401K account is from the employees paycheck. He or she can elect to defer part of their paycheck each month into this account on a pre-tax basis. Employee Contribution Limits. The employee contribution limit for 2009 is $16,500 for an individual. If the person will turn age 50 or older by the end of 2009, he or she can make an additional "catch-up" contribution of $5,500 in 2009. These limits, including "catch-up" limits are indexed for inflation and will continue to be increased each year (by $500 per year). Employer Contribution Limits. In addition to the employees contribution limits, the employer also has a limit on how much they can contribute to each employees account in terms of matching contributions. The contribution limit for the employer is set at 6% of the employee's pre-tax compensation. This means that if an employee makes $75,000, he can contribute as much as $16,500 for 2009. The employer could contribute as a matching contribution as much as $4,500 (that's 6% of $75,000). If the employee was over age 50, he could put in another $5,500 as a "catch-up" contribution, totaling $26,500 for the year. If you have an employer that still makes those kinds of matching contributions, please email me so that I can apply for a job there. :^D Highly-Compensated Employees If you are an employee who earns more than $110,000 in 2009, or you are a 5% owner during the current or previous year, then you are considered a highly-compensated employee. In this case, there may be some additional limits that apply to you. 401K plans are subject to special nondiscrimination tests known as Actual Deferral Percentage tests (ADP). These tests ensure that higher-paid employees do not use the 401K plans to stockpile compensation that would have otherwise been taxable. They also force employers to design the plan to that it attracts participation by lower-paid employees. If the lower-paid employees don't participate, then the higher-paid employees can't contribute as much. In order to pass the ADP test, on of two requirements must be met: 1. The 125% requirement - Under this requirement, the average contributions of the higher-paid employees in this year cannot equal more than 125% of the average contributions by lower-paid employees in the previous year. 2.The 200% / 2% difference requirement - Under this requirement, the average contributions of the higher-paid employees in the current year cannot be more than 200% of the average contributions of the lower-paid employees in the previous year and the difference in the deferral percentages cannot be more than 2%. If the contributions to the plan do not meet the ADP tests, the excess contributions will either be returned to the employee, or re-classified as after-tax contributions. These amounts will be reported as taxable income on your tax return. I know this sounds confusing, but not to worry. Your human resources department will let you know if you need to make any changes to your contributions. If you are an employer who is trying to establish a 401k plan, talk to your personal financial planning advisor who will make sure that you are following these rules. After-tax Contributions Some employers will allow you to make after-tax contributions to your 401K plan. These contributions would be made with money that you have already been taxed on, but they would grow tax-deferred. These contributions also have annual limits. In 2009, the maximum amount that can be contributed to your 401K plan is $49,000 or 100% of your income - whichever is less. These limits are also indexed for inflation and will increase each year. Making your 401K contributions a priority in personal financial planning will ensure that you are able to retire successfully and never run out of money.
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