contribute to before-tax or after-tax for 401k?

Question

the company i work for has a 401k plan that has the option for before or after tax contributions. for before tax, the limits are 1-15% of the paycheck and for after it's 1-3%. the company also matches up to 4% on the before tax contributions. for the after tax, why don't they offer a match and why are the limits so low? please explain as simply as possible, as i am not too literate in all the investment/retirement language (though i want to be someday). thanks in advance.

Answer 1

This is a new program available starting 2007.

For many years, employers have offered a 401k plan. This plan allows you to take money out of your paycheck and put it into a savings account. This money is not taxed now, and sometimes employeers also contribute or match your contributions. These funds will be taxed when you take them out of the account years down the line.

The new program is called a ROTH 401k. This means that you pay taxes on the money now, then put it away to be saved. This is somewhat similar to a savings account from a bank. The difference is that the money is invested how you choose from your employer's options, and your employer may contribute to the account, just like a regular 401k.

My advice: Contribute to both plans if you can. It really is best to distribute your savings as much as possible. Additionally, the more money you save, the more money your employer will contribute.

Answer 2

They don't offer the match because they don't have to. Enough people take them up on the before tax match that they don't have to increase it or move it over to the after tax portion to do it.

As for the limits being so low? It's simply because they haven't taken advantage of the revised limits made available to 401ks in 2001. If you want to contribute more than they are currently allowing then you need to go to your HR and ask them if the plan was amended for EGTRRA. If it has, have them make sure that the limits weren't already raised on the plan documents (some HR people didn't know they were changed and tell their employees the wrong information). If they weren't changed then ask them to amend the plan to allow for larger contributions. They are doing their employees a disservice by limiting the amount you can put away.

The reason that limits USED to be so low was the deductibility of the contributions. It used to be that employers could only receive 25% of the eligible pay. So, if you contributed 15%, received the match of 4%, and contributed 3% of after tax then you would be bumping up against that 25% window (there are other calcs that go into this that's why they limit to 22%). But, 2 things happened with EGTRRA. First they pulled out the employee deferral number from the company deductibilty calculation making it easier for companies to deduct such contributions and 2 they allowed individuals to contribute or have contributed up to 100% of their income (subject to other limitations). This was for those households where one spouse had access to a plan but the other did not...thus the spouse that did have access would defer for the both of them without being limited.

Now whether you should contribute to before tax or after tax??? You should always get the maximum match. So put at least 4% into the regular 401k. After that it's just a personal choice. If all things were to remain the same, neither the ROTH 401k (after tax) or the Pre-Tax deferral option is better than the other. But, if you want to hedge your bets against higher taxes then put some money in the Roth. If you're young then lean more heavily to the ROTH now...and as you get older put less in the ROTH and more in the pre-tax. Reason for that is that now while your income is low you are in a low-tax bracket. Pay the tax...and avoid it later. As you get a little older you want to avoid the tax...so you use the deferral option.

Answer 3

An EMPLOYEE may contribute up to $15,000 to a QUALIFIED 401(k) plan. You may do it all at once or over the course of the year. If you are 50 or over, there is a catch up clause that allows you to contribute another $5,000 a year. These numbers are indexed for inflation at about $500 each per year. Also, if you contribute more than this, you may take a distribution from the plan for the amount over before april 15 and you will not pay a penalty. just be sure you include the distribution in your normal income for the year.

Answer 4

It sounds to me like there are two different retirement plans. I would not want to guess what is going on. You need to write up your questions and give them to the benefits office at work.

You can also write the benefits office and request a copy of the plan documents. They are required to provide them to you. Then take them to someone who is knowledgable and that person can interpret them for you.