401K Contribution Limits for 2012- Should You Be Contributing?

by Fern LaRocca CFP®

in 401K,401k Contribution Limits

The 401K maximum contribution limit for 2012 is $17,000. That means you can contribut a maximum of $17,000 into your 401K plan. If you are over the age of 50, you are able to contribute an additional $5,500 to the maximum 401K contribution limits. This is called the catch-up contributions because so many people are getting a late start in saving for their retirement. After having saved enough money for emergency cash reserves, this is a great way to invest and see you money grow fast. Why? Because of these three benefits:

  • You contribute with money that hasn’t been taxed yet. Let’s say you earn $45,000 a year and you contribute $5,000 to your 401K plan, you will only have to pay income taxes on $40,000. You pocket the cash that you would have had to pay on that $5,000.
  • You don’t have to pay tax on the earnings in a 401K account. Employee B invests $5,000 in a mutual fund in his 401K. At the end of the year, the mutual fund made a $200 profit and would have been taxed as a capital gain. But since the earnings were in a 401K, there is no tax.  In addition, every year after that, the profits compound over time. Many of my clients are in awe of how much their401K maximum balance has grown over time even though they had some bad years.
  • Your employer may match your contributions up to a certain percentage. Let’s say ABC Corporation will match you up to 3% of your salary that you contribute to your 401K. So if Employee A contributes $3,000, ABC Corporation will also add $3,000 in his account. That is a 100% return on your money. It is hard to beat that kind of return, and foolish not to take advantage of it. Yet studies show that most Americans don’t contribute up to the matching amount.

Many people don’t like the fact that their money is tied up in the 401K plan until they are 59 and a half, but that was what the 401K plan was designed for- long term retirement account. Short term or emergency funds should be elsewhere. Because of the benefits described above you would be foolish not to take advantage of contributing to your 401K plan. Because contributions are taken right out of the paycheck, many clients don’t feel like they miss the money. You can also change your withholding exemptions when you contribute a lot to your 401K so you get a bigger paycheck instead of more tax refund. Your Financial Advisor or Wealth Coach can help you with this or refer you to some IRS worksheets.

 

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