Does Maximum Retirement Contribution Include Matching Funds From Employer?
Contributing to a qualified retirement plan usually results in income tax benefits, but setting aside too much results in tax penalties. On certain types of retirement accounts that permit both employee and employer contributions, the Internal Revenue Service sets both a maximum individual contribution limit and a maximum total contribution limit.
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Different Limits on Different Accounts
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Not all retirement plans are equal, at least when it comes to the amount that can be contributed by you and your employer. Some plans, such as traditional Individual Retirement Accounts and Roth IRAs, do not permit employers to contribute to the account on your behalf. Other plans, such as 401(k) and 403(b) plans, permit both employer and employee contributions. Still others, such as Simplified Employee Pension IRAs, only permit employer contributions to the account each year. If you are self-employed, you can contribute to your own SEP IRA because you are technically your own employer.
Total Contribution Limits
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The IRS sets a total contribution limit for the amount that can go into your 401(k) plan or 403(b) plan per year from all sources, including matching funds from your employer. As of 2011, the limit equals $49,000. This limit includes all employee elective deferrals and contributions, employer matching and discretionary contributions, and allocations of forfeitures to the plan. SEP IRA contributions cannot exceed the smaller of $49,000 or 25 percent of your annual compensation. For example, if your compensation for the year equals $30,000, your employer cannot contribute more than $7,500 on your behalf. If you are self-employed, your maximum contribution is calculated with the same formula, but you have to calculate your deduction for your contributions separately.
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Personal Contribution Limits
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The IRS also sets personal contribution limits for the amount that you can put into your 401(k) plan or 403(b) plan. These restrict how much you can add on your own behalf, but may be reduced if your employer contributes a large amount to your plan. For example, in 2011, the annual contribution limit for a 401(k) or 403(b) plan equals $16,500. If your employer makes a $40,000 contribution to your plan on your behalf, however, the total contribution limit of $49,000 restricts your contribution to an additional $9,000 rather than $16,500. With a SIMPLE IRA, you can contribute up to $11,500 and this limit is independent of your employer's matching contribution that the employer must make on your behalf.
Penalties for Excess
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If you make an excess contribution to an IRA, the IRS imposes an extra 6 percent penalty each year the extra contribution goes uncorrected. With a 401(k) plan, you do not get to reduce your taxable income by the excess amount and you must include it as taxable income when you take your distribution, which effectively means you are taxed on the money twice. For example, if you and your employer combine to contribute $50,000, your taxable income only decreases by $1,000 and you have to pay taxes on that $1,000 when you distribute it from your 401(k).
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