How much are you allowed to contribute to your 401(k)? Possibly a lot more than you think.
Since 1983, the IRS has limited the annual contribution by participants. These limits have increased steadily through the years. For calendar year 2018 the IRS allows contributions of $18,500 for employees under 50 years of age.
For those over 50 a “catch up” contribution of $6,000 is permitted for a total of $24,500. Any additional contributions must be made after tax. The employer can, and often does, make a matching contribution on top of what the employee contributes. For participants under 50 the total of all contributions between employer and employee cannot be more than $55,000. Most of my clients have a hard time believing this. For those over 50 the total increases to $61,000! So how in the world do you stuff that much into your retirement plan? A couple of thoughts:
Work For a Company Who Allows It
The IRS determines these limits, however, there is a wrinkle. The maximum contribution for any combination of traditional pre tax 401(k) contributions and Roth 401(k) contributions (if the plan has this feature) is only $18,500. Once the $18,500 ($24,500 for those over 50) limit has been reached, any additional contributions must be made after tax, and you’ll have to check with your employer to see if this is allowed.
I work with a lot of clients at a large employer here in Kansas City that allows both after tax and Roth 401(k) contributions in their plan. I’ve employed this strategy with many clients once their $18,500 limit is reached by contributing with after tax dollars and then performing a Roth conversion within the plan so that any future growth on those dollars become tax free. The only tax implication would be claiming as income the growth, if any, that took place between the date of contribution and the date of conversion.
Once a rarity, it’s becoming more common for employer plans to offer both the after tax and Roth Conversion option. If your plan allows this then options are plentiful. What’s to stop someone from taking a $100,000 inheritance and putting it into their 401(k)? It can’t be done directly, but I’ve had clients live off such an inheritance for two or three years while deferring 80 percent or so of their income into their 401(k) through after tax contributions up to the limit and then making Roth Conversions. Once complete they’ve essentially turned a lump sum of money into a retirement fund which will never be taxed again. Now that’s powerful.
P.S. – – This is a complicated topic and, as always, your Tax Advisor should be consulted before taking any action.