Employer-sponsored 401(k) plans comprise the bulk of personal retirement savings. These plans allow investing with pre-tax funds so that employees can help fund their retirement. Of course, there are some requirements that must be met to enjoy these tax-deferred privileges, and those requirements can change from year to year.
Employees using 401(k) plans should review these rule changes annually to see if they need to adjust their 401(k) contribution practices. These are some of the changes concerning 401(k) plans for 2021.
What is a 401(k)?
The 401(k) is an employer-sponsored retirement plan that allows you to invest a portion of your pre-tax income toward your retirement. The money remains untaxed until you withdraw it from your retirement account. If your plan has a Roth option you can contribute to, those contributions are made post-tax, growing tax-deferred, and are withdrawn tax free.
Initially, the intention was that 401(k) plans would operate to help supplement organizational pension plans. Today fewer companies offer pensions, so their 401(k)’s have become the primary source of retirement savings for most people. Some employers will match employee contributions up to a specified percentage, though that is not guaranteed.
The US Government has strict limits as to how much of your income you can contribute toward your 401(k). Understanding these contribution limits can help you avoid certain fines and penalties.
401(k) Contribution Limit Changes from 2020 to 2021
Not all 401(k) plans are the same. Some allow employees the opportunity to invest both pre- and post-tax dollars in their 401(k), while others do not. If you have the ability, it is wise to consider doing so. This is especially the case for people approaching retirement age.
While limits for employee pre-tax contributions increased by $500 from 2019 to 2020, the limits remain steady for 2021 at $19,500. However, those who are age 50 and over can contribute an additional $6,500 (also the same amount as in 2020) as a “catch-up” contribution.
People making catch-up contributions have the same limits in 2021 as they did in 2020: an investment total of $26,000. This was, however, an increase over 2019 limits that were $1,000 lower at $25,000.
The annual additions paid to an individual’s account can be no greater than 100 percent of the employee’s compensation or $58,000 ($64,500 with catch-up contributions). This represents an increase of $1,000 over 2020 contribution limits.
Depending on their circumstances, people who have 401(k) plans under two unrelated employers in 2021 are eligible to defer a total of $26,000 (the same as 2020). This is true even if they are not generally eligible for catch-up contributions. However, it is up to the employer to keep up with your contributions in this case. You should consult with your plan administrator to determine specific rules regarding catch-up contributions.
If your employer matches a portion of your 401(k) contribution, you might look at it as “free money” as it does not count toward your contribution limit. You will, however, be taxed on this when you withdraw the funds.
Types of 401(k) Plans
Many people use the term “401(k)” as a catch-all phrase when referring to various retirement saving plans. There are many different plans available. Since these are all employer-sponsored plans, you will be limited by what your employer provides as far as variety of plans.
Your plan may be any one or more of the following:
- Safe Harbor
There is one exception; with a Simple 401(k) plan your employer cannot provide any additional options for 401(k) plans. The better you understand your 401(k) plans, contribution limits, and tax implications, the better prepared you will be to avoid unnecessary fines and build a stronger financial future. We advise speaking with a financial professional before making any major decisions. The information provided above is a condensed version of the IRS regulations. Due to the complexity and periodic changes of regulation, it is always best to get advice from an expert!
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