A 401k is a qualified, defined contribution retirement plan that enables an employee and, depending on an employer’s 401k plan document, his employer to make contributions into the employee’s individual retirement savings account. Even if an eligible employee participates in his employer’s 401k, the Internal Revenue Service allows him to make tax-deductible contributions to a traditional IRA established outside of his workplace. The IRS may limit the amount he may deduct based on his modified adjusted gross income (MAGI), however.
In general, a worker becomes eligible to participate in his employer’s 401k plan when he turns 21 and maintains employment with the company offering the 401k for a year preceding the plan’s enrollment period. An eligible employee participates in a 401k when he chooses to make elective salary deferrals into his retirement account. While the IRS does not tax the portion of an employee’s salary that he defers into his 401k account as income, the employee’s deposits remain subject to Social Security and Medicare taxes.
As of publication, the IRS allows an employee under age 50 who participates in his employer’s 401k to defer up to $16,500 of his compensation into his retirement account. The IRS allows a participating employee who is at least 50 years old to defer an additional $5,500, or a total of $22,000. The IRS forbids the amount contributed to a single employee’s 401k account to exceed these limits even if an employer’s 401k plan document permits an employer to make contributions to the retirement accounts of its employees.
Traditional IRA Eligibility
Typically, a taxpayer must earn income to contribute to a traditional IRA and deduct the amount of his contribution on his federal tax return. If a worker participates in his employer’s 401k plan, the IRS may limit or eliminate his ability to deduct his traditional IRA contribution if his MAGI is above certain thresholds. If a person who files his taxes as head of household records a MAGI of $56,000 or less on his federal return, the IRS permits him to deduct the full amount of his permissible IRA contribution. If the person’s MAGI is between $56,000 and $66,000, the IRS allows him to partially deduct his traditional IRA contribution. If the worker reports a MAGI of $66,000 or above, the IRS does not permit him to deduct his IRA contribution on his federal tax return.
Traditional IRA Contributions
As of publication, a worker under age 50 may deposit up to $5,000 in his IRA. If a worker is 50 or older, the IRS allows him to deposit up to $6,000 in his traditional IRA. The IRS taxes contributions to an IRA and interest earned by the account when the account’s owner withdraws funds from his traditional IRA.
Deborah Barlowe began writing professionally in 2010. With experience in earning securities and insurance licenses and having owned a successful business, her articles have focused predominantly on finance and entrepreneurship. Barlowe holds a bachelor’s degree in hotel administration from Cornell University.