The 401k plan is offered to the employees by their employers. It is a tax-deferred and a retirement account. The employee can add the amount to their 401k plan through 401k payroll withholding. In this plan, the employers can contribute to their workers’ plans as well.
But one of the most common questions is ‘How much can I contribute to my 401k plan in 2020?’ In this article, you will get to know all the necessary facts about the 401k plan and the contribution to it.
This money is not taxed until you begin to withdraw it after retirement. However, the Roth 401k plan is withdrawal tax-free. The plan has been named after the section of the United States Internal Revenue Code.
What are the benefits of a 401k plan?
This plan is one of the best options you will have to save up for your retirement. Selecting this option also depends on your goals and the situation that you are in.
By all means, the employee will benefit more from a 401k plan, and the benefit is multiplied if their employer adds to their plan. But sometimes, you can explore different options that are available to you.
401k plans can have a host of benefits which include of:
- Breaks from tax.
- Employers can contribute to your retirement plan.
- You can add extras to your 401k plan.
- People above the age of 72 can still make contributions to their 401k plan.
- 401k plan is protected from creditors.
Rules of withdrawals in a 401k plan
- There are certain restrictions on the withdrawal of the money from your 401k plan. One of them is that when you take out the money; the tax applied will be based on your current income tax rate.
- If you take out the money before turning 59 and ½, you will be charged with a 10% penalty fee as well as applicable taxes.
- At the age of 72, you are mandated to take out the minimum amount from the plan. The Required Minimum Distribution (RMD) plan was 70 ½ before. But following the Setting Every Community Up for Retirement Enhancement (SECURE) act in December 2019, it has been set to 72.
- If you are employed at the age of 72, there is no need for RMDs from the current workplace plan. Although, you will have to withdraw the amount from any other former employer who offered a 401k plan.
The Roth 401k plan differs from the normal one. The 401k was first announced in 1978. The Roth 401k was announced in 2006. The Roth plan was named after the previous US Senator William Roth of Delaware. He sponsored the legislation that made the Roth IRA conceivable.
In 401k, the tax refund is given to you but you will be charged a certain amount when you being withdrawing from your account. In the case of Roth 401k, you will be charged a tax when contributing but the withdrawals would be free of tax.
Contributions that I can make to my 401k plan
- The limit set for the employee’s contribution in 2020 was set to $19,500. This includes employee salary deferrals, after-tax additions to your Roth account in your 401k, or the special Roth 401k plan.
- The $19,500 contribution limit is also applicable to the 403(b) plans as well as most of the 457 plans. This also includes the Thrift Savings Plan offered by the federal government. These limits have not been changed for 2021 either.
- Considering you have more than one 401k account, both the Roth and the traditional account. In that case, the total limit cannot go beyond $19,500. But any other augmentations made to the other retirement accounts and plans (such as the IRA) do not impact your 401k limit.
- If you are 50 or older than that, you are allowed to throw in extra $6,500 additions in 2020. For you, the amount will tally up to $26,000. This has not been changed for 2021 either.
Contribution an employer can make to my 401k plan
Your employer can add to your 401k plan as well. This is what makes this option extremely attractive. The employer can match the amount that their employee added. Taking an example, say you added $1 in your 401k. Your employer can add say, 50 cents or a dollar to match your contributions.
Employers can make voluntary additions that are need not match the employee’s contribution. In this, there are certain limits.
The employer and employee total contribution to the 401k in 2020 is $57,000. For those above the age of 50, the limit is set at $63,500. This includes the additional contributions allowed to those of 50 or above age. (The breakup of 63,500 = 57,000 + 6,500).
Set limit for high pay employees
You will be considered a Highly Paid Employee (HCE) if you earn a high salary. There is a limit set for high-income earners. This is implanted so that rich people cannot benefit unfairly from the 401k plan. IRS has an Actual Deferral Percentage (ADP) test. This is to ensure that the tax amount compensated is equal for all.
The Non-Highly Compensated Employees (NHCE) do not have to participate in the company’s 401k plan. In that case, the HCEs contribution is limited to ensure a proportion.
The federal government offers other plans apart from the 401k and the Roth 401k retirement plans. But these two are most sought after.
Given the fact that, apart from the employee, the employer can contribute is the selling point. The only difference between them is the time period in which the tax is applicable. In 401k, it is during withdrawals whereas Roth’s is while making contributions.
The selection of retirement plans depends on your situation and plans for the future. Not that you cannot have the other if you already have one. But it is advised that you study up which plan suits your interests more. Because, at a certain point, you will be charged for it.
Make sure you are up for it. Although, you can take these from more than one employer, keep a track record of who owes you what. As well as document what you will owe to the federal agencies when applying for these plans.
For years I have studied the irs regulations regarding forms and taxes. All the information in this blog is sourced from the Internal Revenue Service (Irs) of the United States government .
Salesforce Certified SALES & SERVICE Cloud Consultant in february 2020, Salesforce Certified Administrator (ADM-201) and Master degree in “Business Analytics & Big Data Strategy” with more than 13 years of experience in IT consulting.