Retirement Contribution Limit
The Internal Revenue Service imposes a maximum contribution limit to tax deferred retirement accounts each year. This limit is set in order to prevent extremely wealthy people from benefiting too much from the structure. If there were no cap, the wealthiest investors would stand to earn the greatest amount from the accounts. The limit applies across the board, regardless of income, in order to make the structure fair.
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Types
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There are several different types of tax deferred retirement accounts. The term tax deferred means the individual retiree puts pretax dollars into the account, grows those dollars tax free, and only pays the IRS upon retirement when he withdraws the funds. By allowing this preferable tax structure, the IRS encourages saving for retirement. Many individuals will find such an account is offered through their business in the form of a 401(k). However, there are also 403(b) accounts, pension plans and various types of IRAs. The vast majority of these funds are tax deferred.
Limits
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You can check the IRS Contribution and Deduction Limits annually to determine how much you can place into your retirement account. For 2010, the limitation on most retirement accounts was set at $16,500. However, your income may affect the amount you can contribute. As a general rule, you cannot contribute more than your total listed income to a retirement account, even if that amount is under the annual limit.
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Exceptions
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One primary exception to the limits on retirement accounts is the Roth IRA limit. Roth accounts are unique because they do not offer tax deferral in the present year. Instead, an individual can place post-tax funds into the account, grow them tax free, and be excluded from paying taxes on the back end. This structure has an annual limit of $5,000 as of 2010. The Roth plan is considered to be preferable for low income individuals who would not benefit much from the tax deferral today, but would benefit greatly from the tax structure in the future.
Penalties
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Place too much money into your retirement account, you could be subject to excess contribution penalties. You will be asked to withdraw the funds, and you may have to pay a 6 percent tax if you do not resolve the issue. Thankfully, the IRS makes it very easy to fix the problem. You will simply be asked to withdraw the funds before December 30 on the year you made the excess contribution. You will not be permitted to deduct the excess from your income this year. If you do this, you will have no penalty for the mistake.
Considerations
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Most tax and retirement advisors recommend putting the maximum amount possible into a retirement account. The tax benefits offered in doing so can assist you with retirement planning in the current year and over the next many decades. In order to maximize your contributions, you may have more than one retirement account and mix the structures. For example, many tax payers choose to place $5,000 into a Roth IRA each year, and then place an additional large amount of funding into a 401(k) or traditional IRA. You still will only be able to save a sum up to the maximum contribution amount, but by mixing structures you can gain greater tax benefits.
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