Most people never need to worry about a special category of limits on 401k contributions. As a matter of fact, most people don’t even know that this category exists. However, those who have found themselves included in the highly compensated employees (HCE) category, learn quickly about the additional limits that are placed on their 401k contributions.

What Constitutes Highly Compensated Employee

In order to be considered a highly compensated employee, the employee must make over $110,000 per year (2011) AND be in the top 20% of earners within their company. So even if you are the highest paid person working at your company, if you make less then $110,000 annually, then the limits do not apply to you.

Understanding 401k Contribution Limits

Money contributed to a 401k plan is done so tax free. Therefore, in order to keep people from money, there are limits imposed on how much can be contributed per year. In 2011, the maximum individual contribution per year is $16,500. In addition to an individual contribution, employers can make matching contributions. So if an employer pays a 50% matching contribution, and the employee contributed $10,000, then the employer would contribute an additional $5000.

However, the maximum amount that an employer is allowed to contribute is 6% of the employes compensation (salary). So to use nice round numbers, if an employee earns $100,000 per year, the maximum an employer can contribute is $6000. With the 50% match program mentioned before, if an employee were to contribute the full $16,500 per year, the employers matching contribution would be $8250, however for a $100,000 per year earner, that would exceed the 6% limit, therefore the most the employer could contribute would be $6000. This would make the contribution for the year $22,500.

Individuals can contribute to their 401k on an after tax basis. The maximum total contribution for a calendar year is $49,000 or 100% of their salary (compensation), whichever is less.

Additional Limits for Highly Compensated Employees

In addition to the limits set for all individuals mentioned above, HCE’s are subject to further limitations on their 401k contribution limits. For someone who falls into the category of a highly compensated employee, meaning they make over $110k and are in the top 20% of earners in their company, the total contribution that an employer can make is limited. The limit is based on the employers overall 401k participation rate. The contribution to the pool of HCE’s can not be more then 125% of the average of all on the non-HCE’s contributions. So the amount of the contribution is really dependent on how many non-highly compensated employees are participating in the companies 401k plan.

If payments in excess of 125% were made to highly compensated employees, then the funds must be returned to the employee. The employee may use those funds to re-contribute to their 401k as a post tax employee contribution. Any post tax contributions made must be reported as taxable income for tax filing purposes.

photo credit: orudge

2009 401k Contribution Limits

You knew it was coming.  The contribution limits for your 401k have increased for 2009.  For many this doesn’t mean much, because who wants to put more money in their 401k right now, right?  I’m sure many have perceived the 401k as one of the biggest money traps for 2008.  But for those that see this as an excellent buying opportunity in the market, the increased 401k contribution limit for 2009 might be at just the right time.  With S&P 500 closing down -38% for the year, all contributions in 2009 could potentially be investing near the bottom of the market (at least we hope).

If this article was helpful, you may also want to check out these posts as well: 7 Things To Know About The 2010 Roth IRA Conversion,7 Things You Need to Know About the Roth IRA for 2009,7 Questions To Ask Your Financial Planner.

New 401k Contribution Limits for 2009

The 401k contribution limits jump up to $16,500 for 2009. That’s a $1000 jump from the $15,500 limit in 2008 (6.5% for all you percentage people out there).  If you are financially able, being able to sock away $16,500 pretax is sure fire way to get on the fast track to a successful retirement.  If you are younger, you could also consider the Roth 401k for some serious tax free earnings at retirement.  But what about the late starters?

Catch up Contribution Limits for 2009 Increased Too

For those that got a late start saving for their retirement, the 2009 401k contribution limits have increased the “catch up” provision as well.  For those over the age of 50, you are allowed the $16,500 plus a “catch up” of $5,500 for a total contribution of $22,000.  For all the procrastinators out there, this gives them an excellent opportunity togrow their retirement nest egg to a respectable level.

Recap of Changes:

• 2009 401k Contribution Limit: $16,500

• 2009 Catch-Up Contribution Limit (if you are age 50 years old and older): $5,500

How Do You Change Your Contribution Amounts?

For those that are already maxing out your 401k contributions, you may want to double check with your benefits department to ensure that it continues.  You may have to manually increase it to make sure that it happens.  If that’s your plan, go ahead and change it immediately to make sure that don’t put it off too long into the new year.

There are no doubts the rules for qualified retirement plans such as 401k plans are complex. Your plan administrator should have documentation outlining the rules that apply to your particular employer’s plan.  That document should explain these limitations as well as other rules or regulations that might apply.

Other reads on 2009 contribution limits:

• My Dollar Plan: 2009 Roth 401k and Roth IRA limits
• Consummerism Commentary: Traditional and Roth IRA Contributions
• Think Your Way To Wealth: Just in Case You’re still Investing….