401K plans are qualified retirement saving plans for the benefit of individuals to save adequate funds for their post retirement life. The IRS sets a maximum limit as well as the pre-tax amount an individual can contribute to the 401K plan annually. The amount is revised by the IRS every year.
For example, in the year 2005, the maximum allowed pre-tax contributions were limited to $14,000. In 2006, it was revised to $15,000. These limits announced are based on the Economic Growth and Tax Relief Reconciliation Act which was released in 2001.
Even if a person earns income from multiple sources or multiple employers, the maximum contribute remains the same and the aggregate of all income sources are taken in to account.
For catch-up contributions which are eligible for people who have crossed 50 years, an additional contribution amount is allowed. The additional contribution amount was $4000 in 2005 and was revised to $5000 in the year 2006. It remained as $5,000 in 2008 and was again revised to $5,500 in 2009.
After the year 2006, the limits are subject to Cost of Living Adjustments popularly called COLA. If the pre-tax contributions of employees do not exceed the maximum allowed contribution limits of the 401K plan or IRS annual dollar limit, even the catch-up contributions falls into the category of regular pre-tax contributions. This is to avoid discriminating the highly paid employees.
For arriving at the maximum contribution limit, there are various factors that are considered. Some of them include salary, guidelines of the government and the plan of the sponsor.
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