- Technically, you do not receive a deduction for your contributions to a 401k plan. Instead, you contribute money to your 401k on a pre-tax basis by deferring a portion of your salary. Your deferral then reduces the amount of your wages, which in turn lowers the amount you pay in taxes.
- Any contributions made by your employer to your 401k on your behalf are not taxable to you. Moreover, your employer will receive a deduction for any contributions made on your behalf to your retirement plan in an amount not to exceed a limit prescribed by law.
- Given the tax benefits individuals receive by participating in 401k plans, Congress created limits for contributions. The amount is adjusted annually for cost of living increases. You may defer up to $16,500 of your wages in 2011. Also if you are at least 59 1/2 years old and if your plan allows, you may make catch-up contributions. Your catch-up contributions are limited to $5,500 in 2011.
- In general, distributions from your 401k must be included in your gross income. You may take distributions from your 401k only at certain specified times. Unless you meet certain statutory exceptions, you must be at least age 59 ½ in order to take a distribution from your 401k plan. Early withdrawals face an additional 10 percent tax penalty.
- There are 401k plans that allow you to make after-tax contributions to a 401k plan. These do not provide any immediate tax benefits. Roth 401k accounts require individuals to pay tax now and the contributions grow tax-free and then are withdrawn tax-free in retirement. You must meet certain income requirements in order to make contributions to a Roth 401k. The contribution limits are the same as traditional 401k plans and if you have both a 401k and a Roth 401k, the contribution limits are counted in the aggregate.
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