401k contribution limits

How does a 401k plan work?

In general, subject to your employer retirement plan 's rules and the Internal Revenue Code (IRC) annual 401k maximum contribution limits, you decide how much money you want deducted from your paycheck each pay period for your 401k contributions.

The Internal Revenue Code (IRC) 401k contribution limits (401k maximum contribution) are:

• $15,000 for 2006.

Also, if you are age 50 or older by December 31st you can make additional 401k catch up contributions (401k maximum catch up contribution) of up to

• $5,000 for 2006.

The amounts you contribute to your 401k account are deducted from your paycheck before federal taxes, as well as most state income taxes, are calculated.

That means that by contributing to a 401k, you can actually lower the amount you pay in taxes each pay period.

For example:

If your gross earnings are $1,500 each pay period and you defer 6% ($90), you will be taxed on only $1,410.

You will not pay federal or state taxes on this money (or any related earnings on your investments) until you make withdrawals from your plan account.

At that time, you may be in a lower tax bracket.

Your Social Security taxes, however, will be the same as if you did not participate in the plan. This means that participating in a 401k plan will not reduce your Social Security benefits. Click here to read more about Social Security and Social Security Benefits.

Some plans also allow participants to make after-tax contributions.

You decide how to invest the money you contribute, selecting appropriate investment options from a menu of investments your plan offers.

By investing a set amount regularly, you can take advantage of dollar cost averaging as you save toward retirement. Click here to read more about Dollar Cost Averaging.