What Constitutes A 401K Contribution
401K Contributions are unlike those of traditional retirement or investment plans that have a set dollar amount that an investor contributes. Instead of a specified dollar amount, 401K contributions are based upon percentages of income. Under Federal guidelines, a contributor can set aside up to 6 percent of his or her salary in a before-tax account, which means that the money you contribute reduces your taxable income. An additional 6 per cent can be placed into an after-tax account that will earn dividends but has no effect on your taxable income. In most cases, the minimum contribution is set at 3 per cent, but some companies may vary that.
One thing to consider when you set up your 401K contributions is that most employers only match contributions that go into the before-tax portion of your plan, and even if you contribute to the maximum of 6 per cent, some employers only match contributions up to 3 or 4 per cent. That doesn't mean you shouldn't contribute the maximum - it is a tax benefit, after all - but it means the employer will not match any contributions above their maximum. For example, if you are contributing 6 per cent before tax and 6 per cent after tax into a 401K plan, and your employer has 50 per cent match contributions up to a maximum of 4 per cent on a before tax basis, that means your employer will contribute 50 per cent of what you contributed on the first 4 per cent of your 401K contributions in your before tax account.
Although you can only withdraw funds from your 401K plan before retirement age for emergency reasons, you do have the option to borrow against it if your employer allows for that. The interest rate is quite low, but you are paying it to yourself rather than to a bank. In addition, the money comes out of your paycheck, so you are not tempted to not repay the money you borrowed against your 401K contributions. Some companies only allow you to borrow against you're the contributions you actually made, so you will need to check your company's guidelines.
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