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Q&A: Get the inside scoop on the 401(k)

The inside scoop on the 401(k)

Since there have been many dire predictions about the availability of adequate retirement benefits through Social Security in the coming decades, combined with the near obliteration of pension plans, why are there significant caps on what employees can contribute to 401(k) plans and IRAs? I don't think the maximum contribution has been increased for the last three years.

Maximum contribution to a 401(k) for folks under 50 is $16,500 a year. That increases to $22,000 per year after age 50, but it is commonly known that most people are unable to begin making serious effort toward saving for retirement until after they reach their 50s when their kids are grown. If a person doesn't start making serious contributions until then, even saving the maximum amount is not going to be enough to fully support someone for the remainder of their life after retirement, particularly as life expectancies continue to increase.

The law allowing taxpayers a break by deferring income was established in the IRS code in 1978. Two years later a benefits consultant named Tom Benna used that break to create a simple way to save for retirement. It was the 401(k).

The federal government walks a tight line with retirement accounts such as a 401(k). It wants to encourage people to save for retirement, but it also needs to make sure it doesn't go too far and cut into its yearly cash flow from income tax revenue. Because contributions are tax-deferred, raising the cap on contributions would act to lower tax revenues.

For other answers to your questions we consulted Bo Bohanan, director of retirement plan consulting for Raymond James of St. Petersburg.

He said caps are adjusted annually for cost-of-living adjustments but generally are changed only in $500 increments. The contribution cap for 401(k) plans has changed over the years, but not necessarily every year. In 2008 it was $15,500. That was bumped to $16,500 for 2009 and remained there until this year, when it was raised to $17,000.

Those over age 50 can add $5,500 in "catch-up" contributions, a number that is also tied to inflation, Bohanan said.

Interestingly, Benna, known as the "father" of the 401(k), is no fan of the current iteration of his creation.

Benna told a year ago that the plans got too complex as they got more popular. "Now this monster is out of control. We went to three options, then to six, then to seven, then to 15. It is far beyond what most participants were able to deal with," Benna told "And I am not convinced we have added value by getting more complicated."

He has urged Congress to overhaul the system.

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Q&A: Get the inside scoop on the 401(k) 10/15/12 [Last modified: Monday, October 15, 2012 6:08pm]
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