The annual 401k contribution limit has now been given additional attention by the federal government. Employees who were previously unenthusiastic about their 401k plans can now breathe a sigh of relief, due to recent amendments to the Restoring Earnings to Lift Individuals and Empower Families (RELIEF) Act of 2001. The RELIEF Act wants to encourage workers to increase the amounts that they can accumulate in the 401k retirement account.

Before the RELIEF Act of 2001, there has been very little improvement made to the annual 401k contribution limit. It had been increasing every year at a sluggish pace, so even employees who had contributed steadily to the account failed to envision accumulating enough for a comfortable retirement.

First, let us define the nature of 401k plans before we explain the significance of the RELIEF Act, in terms of the annual 401k contribution limit. From the point of view of the IRS, the 401k plan is a contribution plan in which a certain percentage of the worker’s salary is deducted and provided as payment to the plan. It is not a defined benefit plan because the amount that the employee will receive at retirement is unspecified. Rather, the worker specifies the percentage of his salary that will go into the plan, and he or she will be able to chose where the money will be invested. The amount that he will receive at retirement will depend on the accumulated contributions plus the earnings of these monthly deductions.

An additional benefit for the 401k plan is that the amount set aside is taxed immediately, and so are any earnings as a result of investing the money. The income tax will only be applied at the time when the employee withdraws the money at retirement.

However, there is an annual 401k contribution limit that restricts the amount that an employee would be able to accumulate for his retirement. In the event that he exceeds this value, he might be liable for the payment of additional taxes and penalties. If the employee notices that he has surpassed this limit, he has until April 15 of the next year to withdraw the excess amount.

The good news is that starting in 2004, the annual 401k contribution limit has been rising at a faster rate. In 2004, it became $13,000 and in 2005, it reached $14,000. In 2006, the limit was raised to $15,000 and in 2007, it was increased to $15,000. In 2009, it was raised to $16,500, and in 2010, it will be adjusted based on the index for inflation in increments of $500. These values are applicable for workers who are less than 50 years old. Those who are 50 years of age or more have an additional $5,000 as mitigating contribution. In 2009, the catch-up contribution was increased to $5,500, so a 50-year-old worker can contribute up to $22,000 every year.

For an employee to optimize his contributions, he can compute his maximum percentage, which is obtained by dividing his allowable maximum contribution by his annual salary. This percentage should then be applied to his salary every payday.