A 401(k) plan is an employer-sponsored, tax-deferred retirement account. 401(k) plans are only available through a job within the United States. With a 401(k) plan you can invest pre-tax money into the stock market and defer paying taxes until you withdraw from the account upon retirement.
401ks are one of the absolute best vehicles for investing since you’re adding pre-tax money. Adding money to a 401k – especially when you get a company match – is usually considered the best (commonly available) place you can put your money. If you have a company match, I’d recommend you do everything you can to contribute at least enough to get the company match.
401(k) Contribution Limits
The IRS website lists up to date contribution limits for each year. In 2020, the maximum contribution amount was raised to $19,500 per year. Those 50 or older are allowed to contribute an additional $6,500 for a total of $26,000 in 2020.
(Under Age 50)
This is your personal maximum contribution – not the total amount that can be contributed. If you have an employer match, that is not considered part of this maximum contribution.
There is a maximum amount for your contribution AND your companies match which starts at $57,000 total for the year. Chances are your company isn’t matching your contribution dollar for dollar, making it rare to hit this limit.
What Should You Invest in Within Your 401k?
The simplest portfolio you can go with is a target-date retirement fund. These have names like “Vanguard Target Retirement 2045 Fund Investor Shares” which is what you might invest in if you want to retire sometime around the year 2045. If you’ve never invested before, these are usually a good first step.
For more information on how to invest within your 401k, check out Minafi’s free Minimal Investor course, which goes a number of things including how to evaluate the funds in your 401k, how fees work and which funds you should pick to maximize tax-efficiency.
What If You Contribute More Than the Maximum to Your 401(k)?
If you’re anything like me, your 401(k) website doesn’t make it easy to hit the yearly maximum target. Fidelity, for example, only lets you set a percentage of your income to allocate and it must be a whole number! I’ve gone over every year since that change.
If you do go over, the first thing you’ll want to do is ask the payroll department how they’ll handle it. Usually, it’ll work out to be something like this:
- In the first few months of the year, the accounting department will figure out how much you exceeded the contribution amount by.
- They’ll withdraw that amount and any match from your 401(k) account.
- You’ll have the amount you contributed added to your paycheck and will be required to pay taxes on it at your ordinary-income rate.
Some companies will do this automatically, but it’s better to check in with them if you already know you’ve exceeded the maximum contribution. Companies need to make this refund before taxes are due in mid-April, giving companies a lot of time to issue this correction. You obviously want that money as soon as possible – so be sure to ask about it!