How does a 401k plan work?
A 401k plan is a retirement plan set up by your employer. When you join a 401k, you agree to contribute part of your salary to the 401k account. The money you contribute to your 401k is deducted from your paycheck before income taxes are taken out, so you end up paying less income tax. Additionally, you don't pay taxes on the money you contribute (and any interest it earns) until you withdraw money from your account at retirement - so you enjoy the benefit of several years worth of tax-deferred compounding (which means your savings add up quickly!).
How much money am I allowed to contribute each year to a 401k?
If you are under the age of 50, the 2007 limit for contributions to your 401k plan is $15,000. This limit is generally adjusted for inflation in $500-$1,000 increments annually. In addition, highly compensated employees are usually limited in how much they can defer due to IRS testing requirements.
If you are over the age of 50, you now also have to the option of making "catch-up contributions" in order to accelerate your savings. As mentioned above, the maximum amount of employee contributions for the year 2007 is $15,500. However, if you are over 50, you have the option of contributing an additional $5,000, bringing the limit up to $20,500. Similar to the increase in the contribution limits, this "catch-up contribution" amount may also be adjusted annually for inflation.
What is a Roth IRA?
A Roth IRA is an individual retirement account created by the Taxpayer Relief Act of 1997. Named for former Senate Finance Committee Chairman William Roth, Jr., this IRA offers more incentives to boost your retirement savings, as well as more ways to use your nest egg.
Unlike traditional IRAs, contributions to a Roth IRA are never tax-deductible. However, the money in your Roth IRA, including earnings, can be withdrawn tax-free. Of course, you must conform to the plan provisions to get this tax-free advantage.
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