What is the maximum 401k contribution per year?
You've probably heard that you should max out your retirement contributions each year, if you're financially able to do so. Aside from the obvious reasons - a little saved now can be worth more than a lot saved later - the government puts a limit on how much money you can put into a retirement account each year. The maximum amount generally increases each year, so even if you put aside the maximum last year, it's worth checking to see if you can increase your savings.
Notice that I said generally, not always...and as it happens, the maximum 401k contribution has stayed the same in 2011 as it was in 2009 and 2010. If you are under age 50, you can contribute a maximum of $16,500 to a 401(k), 403(b), or 457 plan; if you are 50 or over, you can put in an additional $5,500 (for a total of $22,000). Note that you may have multiple plans (for example, a traditional and a Roth 401k) but the combined contributions cannot exceed these limits. Additionally, you cannot contribute more money to a retirement plan than you actually earn!
In addition to the amount you put in, your employer is permitted to contribute to your account as well; this contribution (generally in the form of matching funds, such as a 50% match on your savings) must be made with pretax dollars regardless of whether you have a traditional or a Roth account. The employer contribution can be up to 25% of the employee's pretax earnings, up to a total of $32,500. This means that the combined contribution (employee + employer) can reach a total of up to $49,000 (more if you're over 50).
Maxed out your 401(k)? Not to worry - you still have IRA contributions to make! IRAs and 401k plans are completely separate; maxing out one doesn't affect your ability to contribute to the other. However, the IRA contribution limits are much lower: $5,000 per year, or $6,000 if you're 50 or older. As with the 401(k), you can divide your contributions between multiple IRAs, which may be traditional, Roth, or a combination, but the total contribution must be no more than $5,000 (or $6,000) per year.
Do note that if you make a lot of money, you may not be eligible for certain types of retirement accounts; once your income reaches six figures, you'll want to consult with a tax professional.
401(k) with ETFs: Good Combination or Bad Idea?
You may or may not be familiar with ETFs, or exchange-traded funds. ETFs are similar to stocks, and are actually traded on stock exchanges. An ETF is basically a basket that holds a collection of assets for you to invest in, such as stocks, bonds, and commodities. The price of the ETF is approximately the same as the value of its assets. Many investors find ETFs attractive because they are not actively managed and thus have lower costs than other investment products. They also tend to have fairly low capital gains, making them efficient for taxation purposes.
The question is, should you be holding ETFs in your retirement plans? At the start of 2010, about $4 billion in 401(k) assets was in the form of ETFs, so a lot of people seem to think so.
The extremely low expense ratios offered by exchange traded funds can definitely make them an attractive choice; lowering fees can dramatically impact your return on investment over the long run. They also allow you to diversify without the hassle of choosing stocks or funds yourself.
However, ETFs are often used for timing the market, which is at odds with the buy and hold strategy appropriate for retirement funds. Additionally, because 401(k) and IRA plans are already tax-advantaged, the tax benefits of an ETC don't apply.
So should you use an ETF in your 401(k)? As with many financial questions, the answer is: it depends. If you want to actively manage your portfolio - for example, investing in commodities without the hassle of taking possession, or making sure that you don't have multiple holdings that are invested in the same company - ETFs can give you the control you seek. If you tend to be a hands-off investor, however, the standard mutual funds offered by your company's plan may be just fine for you.
401(k) Direct Rollovers
A direct IRA rollover is when you move your retirement savings from your 401(k) directly to your IRA from the old account, through a trustee to trustee transfer. When you're rolling over a 401(k) to an IRA you always want to make it a direct rollover, as this avoids having to pay taxes or penalties; if you ever handle the money, you can trigger early withdrawal penalties that, combined with taxes, can wipe out half of your savings. The other type of rollover is, surprisingly enough, called an indirect rollover; when you do an indirect rollover, you get a check written out to you (with 20% of your IRA withheld) and you have 60 days to get that money deposited into an appropriate retirement account before triggering the aforementioned penalties. If for some reason you do an indirect rollover, you'll need to make up that 20% with other funds (it's held to pay taxes if needed) in order to avoid taxes on the part not rolled over.
Generally, when you're holding stock in your 401(k), you have two options. You can transfer the stock directly to your IRA, or sell it and transfer the cash to your IRA; in the latter case, you need to make sure that the sale occurs within 60 days of the rollover to avoid paying taxes.
While you would normally move your money into a traditional IRA or a rollover IRA, it is also possible to move it into a Roth IRA. In this case, you must pay taxes on the money (because the account was funded with pretax dollars) but you do not need to pay the early distribution penalties and taxes, provided you do not withdraw the money for at least five years. Obviously, when doing this you want to have cash on hand to pay the taxes, so that they don't reduce your retirement savings. This is essentially one way of getting around the $5000/year limit on Roth IRA contributions. (This limit will rise with inflation after 2010, and is also higher for people over 50).
Note: there are special rules for members of the military; see IRS Publication 3, Armed Forces' Tax Guide for details.
You can check the IRS Rollover Chart to see whether you can do a rollover between two accounts.
Roth IRA vs 401(k)
There are a great number of different retirement plans out there, but the two most common are the 401(k) and the Individual Retirement Account (IRA); each have their advantages and disadvantages. There’s a good chance that you want to have both!