What are the Different Types of 401k Limits?

One of the best ways to save for retirement is by taking advantage of a 401k savings program. A 401k plan allows you to put pre-tax earnings into a savings account. The money in the account is then used to buy into a variety of investment options under the employee's direction in the hopes of further increasing the funds that will be available to withdraw upon retirement. In order to ensure 401k plans provide the maximum benefit to the most people, there are a variety of limits tied to participation in a plan. These 401k limits are mandated by the US government and imposed on contributions, loans, and withdrawals.

Each year, the federal government sets the 401k limits for individual participant contribution. This limit is reviewed annually and increased in $500 US Dollar (USD) increments to account for cost of living increases. If the individual is over the age of 50, he is allowed to contribute an additional amount per year, referred to as a catch-up contribution. Like the standard 401k limits for contributions, this is reviewed annually and increased in $500 (USD) increments when applicable.

An employer can also contribute funds to an employee's 401k account as long as the individual falls within the defined 401k limits. These can be done on a matching basis, mirroring a percentage of the employee's contribution, or a set percentage, independent of the amount the employee chooses to contribute. There is no monetary limit for these contributions; however, they cannot exceed 6% of the employee's annual income.

If an individual wishes to contribute additional funds above the basic 401k limits, he may do so on a post-tax basis. Up to $5,000 (USD) a year can be contributed to a separate retirement account for individuals under the age of 50. An additional $1,000 (USD) is allowed for those over 50. This post-tax account is commonly referred to as a Roth 401k or Roth individual retirement account (IRA).

The 401k limits imposed on withdrawals from the plan are structured on more of a penalty basis. Since the 401k plan is designed to provide money for retirement, early withdrawals are highly discouraged. An individual is allowed to withdraw money for hardship purposes, including medical expenses and home foreclosure, or more positive scenarios, such as buying a home or paying for college. These withdrawals are subject to a 10% penalty and any applicable taxes.

In order to discourage withdrawals, most employers offer the ability to take loans from the 401k account. The 401k limits for loans include three basic provisions. A loan can only be taken for the lesser of 50% of the vested account balance, or $50,000 (USD). Two loans can be held at one time as long as they were taken out at least one year apart from each other and do not exceed the maximum loan amounts when combined together. The loan repayment schedule may not exceed five years, but can be extended if the loan is specifically taken for the purposes of purchasing a home.