American workers often have the option to set aside money before taxes for retirement. These retirement plans are called "401(k)" plans and often involve a company matching all or part of an employee's contribution to the plan. This company match is a benefit to the employee and serves as incentive to contribute to a 401(k). The federal government currently sets limits on 401(k) contributions that can be made by an individual, but the employer match is not included in those limits.
In 2009 and 2010 employees were allowed to contribute $16,500 to their 401(k) plan. Future contribution limits will be determined by the United States inflation rate, with increases coming in increments of $500. If inflation levels during the previous year were not enough to warrant an increase, the rate will remain at the same level for the next year.
This limit is only for your own contributions. So if you employer agrees to match $1 for every $2 you invest, and you invest $16,000, your total contribution for that year would be $24,000. Again, you can contribute up to $16,500 of your own money and receive an employer match on those funds.
Employees who are over the age of 50 are allowed to make "catch-up" contributions, helping them prepare for retirement. In 2009 and 2010 the "catch-up" limit was $5,500, meaning an employee could set aside as much as $22,000.
Companies are not required to allow catch-up contributions. Some companies may allow the contributions, but only make matching payments on a certain portion of those contributions.
In a standard 401(k), you do not pay income tax on your contributions as they are invested. However, when you retire and begin to withdraw the money you have set aside, you will have to pay federal and state income taxes on those proceeds.
A Roth 401(k) works in the reverse of a standard 401(k). Under a Roth plan, you pay federal taxes on the funds before you invest them. However, as you retire and begin withdrawing the money, all of your contributions and any profit you have made off the investments are tax-free.
Roth plans are subject to certain restrictions and contribution limits. They are also not open to people with high-income jobs, so consult an investment professional to see if you qualify for the Roth plan.
Companies are not required to match 401(k) contributions. Many companies were forced to suspend matching during the 2008 financial crisis. Your own contributions are subject to investment risk, so invest carefully and consult an investment professional.
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