What Is a 401(k) Contribution?
A 401(k) contribution is an amount that a worker opts to save from their pay for an employer-provided retirement account. The portion of the worker’s income that they are saving for retirement is put directly into their 401(k) account rather than being given in cash.
The biggest benefit of a 401(k) account is its tax benefits. Depending on whether it is a traditional or Roth 401(k), saving money via a 401(k) can reduce the worker's taxable income for the current year or provide tax-free income when the worker retires.
How Much Can You Contribute to a 401(k)?
The Internal Revenue Service (IRS) specifies each year what the maximum amount that employees can contribute to their respective 401(k) plans will be.
- For the year 2024, you may contribute a total of up to $23,000 as an employee contribution into your respective 401(k) plan.
- If you are at least age 50, you may also contribute an additional $7,500 as a catch-up contribution.
It is important to note that the maximum contribution limits set by the IRS for your 401(k) plan will also include all of the employee contributions made, or recorded, within the entire year, to both traditional as well as Roth 401(k) plans.
Other types of retirement accounts, such as IRAs, do not get counted in your total annual contributions to your 401(k) plan and are governed by different rules established by the IRS..
Traditional vs. Roth 401(k) Contributions
- Contributions to traditional 401(k)s are generally made using pre-tax dollars; thereby reducing your taxable income for a given calendar year. Taxes are due when retirement funds are withdrawn.
- Contributions to Roth 401(k)s are generally made using after-tax dollars. Therefore, when funds are withdrawn from a Roth 401(k), the funds are generally tax-free
- Some employers allow their employees to divide their retirement plans between both types: traditional and Roth 401(k)s
What Is a 401(k) Retirement Plan?
The purpose of the 401(k) employer-sponsored retirement savings plan is to help employees save for their future through long-term income from an established account under IRS guidelines. Employees will defer a percentage of their salary (or wages) to fund their individual retirement account. Employers will then contribute that same amount into their employees’ individual accounts.
Some key aspects are as follows:
- Contributions can be automatically deducted from payroll.
- Growth inside the account will either grow tax-deferred or tax-free depending on the particular plan
- Aside from a company match, employers may offer additional contributions to help their employees accumulate additional savings
- Employees will also have the ability to transfer (or roll over) the balance of their plan to another 401(k) or individual retirement account (IRA) account if they change or leave their job.
Employers may also maintain and/or sponsor other types of retirement savings programs, which will be recorded on Form 5500 and submitted to the IRS and Department of Labor on behalf of their employees.