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Chapter 2. The Rules: Understanding Your... > Limits on Your 401(k) Contributions ... - Pg. 25

The Rules: Understanding Your 401(k) Congress has been active in 2001 with the enactment of the Economic Growth and Tax Relief Reconciliation Act. This act, coupled with tax law changes from 1996 and 1997, has significantly changed how 401(k), 403(b), and 457 plans will operate. Many companies hate performing nondiscrimination tests, so Congress has pro- vided a way to get around them--a "safe harbor." If plan sponsors guarantee a contribution to your account of at least 3 percent of your pay, they could avoid the tests. There are also many other formulas that qualify. The point to remember is that there may be a way around your company's low 401(k) participation rate and the cap on HCEs, but it's going to cost the company money. Of course, the low-cost option is buying this book for all your co-workers and requiring them to read it. Now there's an idea worth mentioning to the boss! 25 Limits on Your 401(k) Contributions (IRS Code 415 and 401) If we had our way, we'd let you contribute as much as you can to your 401(k) account. Your employer probably feels exactly the same way. After all, it's for a good purpose--your retirement. Well, Congress and the IRS don't see it that way. You see, every dollar that's put in a protective shell is one less dollar to be taxed to support government. Shelter too much money from taxes, and government has to go on a diet. Government never has been very good at losing weight. A healthy appetite for tax dollars is why the IRS limits you and the plan sponsor's contributions to defined contribution plans. You can find these limits in IRS Code section 415. We lovingly refer to them as the 415 limits. The good news is that, beginning in 2002, the amount that you and your employer can contribute to your 401(k) account will increase to $40,000 or 100 percent of pay, whichever is less. That total includes all contributions to your account (pre-tax and after-tax, by you and by your employer) from all defined contribution plans (401[k], thrift, profit-sharing, ESOP, and money purchase). That seems to cover everything, doesn't it? Well, there's an exception to every rule. The 415 limits do not affect your ability to contribute to deductible or nondeductible IRAs. (See Chapter 9, "IRAs Versus 401[k]s--Which Is Better?"" for more on IRAs.) IRS Code section 401 sets a limit on the amount of your pay that may be considered for contributions and match. In 2001, the limit was $170,000. 2002 bumps it up to $200,000. The 401 limit increases in $1,000 increments based upon inflation. If you earn more than these limits (it could happen), you should ask your employer to offer a Supplemental Executive Retirement Plan (SERP). This way, you'll get matched on all your pay, not just some of it. Our Advice Good news for "older" Americans (and HCEs): Beginning in 2002, if you are age 50 or older, you can make an additional $1,000 pre-tax contribution to a 401(k), 403(b), or 457 plan, and you can make a $500 contribution to an IRA (traditional or Roth) or SIMPLE plan. To be eligible for these "catch-up contributions," all you need to do is meet the age requirements and contribute the maximum allowed by your plan or by law, whichever is less. HCEs are eligible for this extra amount, too, even if capped at a lower rate. The dollar limits increase each year, so, by 2006, you will be able to contribute an extra $5,000 to 401(k)s and $2,500 to IRAs. See, age does count for something.