401(k) plans give you the option to divert a portion of your salary to a tax-sheltered retirement savings account set up by your employer. The limit on how much you can put away in a 401(k) each year, $15,500 ($20,500 for individuals age 50 or older if the plan allows this additional contribution), is far greater than the $5,000 IRA cap ($6,000 for investors age 50 and older).
Depending on your salary and the limits specified by your employer's plan, you may not be able to contribute the maximum. Most firms allow contributions of between 2% and 15% of your compensation.
A 401(k) counts as a company retirement plan for purposes of determining your right to deduct traditional IRA contributions, but deferring salary into a 401(k) may increase the size of your allowable IRA deduction. Because 401(k) contributions reduce your taxable salary, they may pull your adjusted gross income (AGI) down to a level that permits you to deduct your IRA contributions. If want to make deductible traditional IRA contributions, but your income is too high, consider contributing to a Roth IRA.
Your 401(k) plan lets you save for retirement while deferring income taxes on the saved money and earnings until withdrawal. Many employers offer 401(k) plans to which you can contribute a percentage of each paycheck. Many companies even match up to a certain percentage of your contribution. Check with the benefits coordinator at your company to find out more.
Matching Contributions
A special attraction of 401(k) plans is that many firms offer to match part of the employee's contribution. Matching contributions don't count toward the annual contribution cap. However, if you quit your job after just a few years, you may have to forfeit part or all of the matching deposits, depending on whether or not you're considered vested in your 401(k).
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