A 401k is a qualified retirement plan that allows you to defer a portion of your income on a pretax basis for retirement. This type of retirement plan could be offered by your employer, or you could have one on your own as a sole proprietor. If you have a 401k, you have to follow the rules regarding annual contributions, including the maximum amount you can invest.
The main way that you can contribute to a traditional 401k is through salary deferral. The money is contributed before taxes are taken out of your paycheck. This allows you to set aside money to invest for your retirement. As of 2010, the maximum amount of money that you can contribute to your traditional 401k from salary deferrals is $16,500.
As you get closer to retirement, the Internal Revenue Service allows a provision called the catch-up contribution. This makes it possible to contribute more to your 401k on an annual basis. You can make the catch-up contribution once you reach 50, and it allows you to put another $5,500 into your 401k. This brings the total of your maximum annual contribution to $22,000, as of 2010.
In addition to contributing money to your 401k, your employer can also contribute money to your account. This is done as an extra incentive to employees, and it also provides the employer with a tax deduction. The amount you contribute to your account can be matched up to a certain percentage by your employer. The employer can make elective contributions up to 6 percent of your annual income. It can also make matching contributions based on the percentage that you contribute.
If you are a sole proprietor, you can have a type of account known as the solo 401k. With this account, you can put aside more money than you would normally be able to with another type of retirement account. You can still set aside the $16,500 or $22,000, depending on your age, but you can also contribute up to 25 percent of your business income. This allows you to put aside a maximum of $49,000 or $54,500 per year, depending on your age.
Some 401k's allow you to make after-tax contributions to your account. Once you reach your pretax contribution limit, you can then put in after-tax money. When you add up all the different types of contributions that you have made, they have to stay within the limit that is set for 401k's. As of 2010, the total annual limit is $49,000.