Question: This may sound dumb, but I keep reading that I should maximize my 401(k) contribution. However, if I go over the $10,000 annual contribution limit, won't I be assessed a penalty by the IRS? So, if I can contribute up to 15 percent of my salary but that causes me to exceed the maximum dollar contribution limit, is it still wise to contribute the 15 percent?

TB: Your question isn't dumb at all and, as a matter of fact, it is asked frequently. Before I answer your questions, I want to let you know that the maximum dollar limit is now $10,500 rather than $10,000.

To answer your first question, if you contribute more than the dollar amount allowed, you need to withdraw the excess contribution plus any investment income by April 15 of the year following the calendar year in which you contributed too much. The excess contributions that are applicable to this question are taxed twice if they are not withdrawn in time. Any amount contributed in excess of the $10,500 limit cannot be deducted, which means the employee must pay tax on it when it goes into the plan. If you don't withdraw the excess prior to the deadline, it must stay in the plan and then becomes subject to the plan's distribution provisions. This means the excess can be taken out of the plan after the deadline only for reasons that are permitted for 401(k) plans and this amount will be part of the taxable distribution. As a result, you will pay tax on this amount twice plus the 10 percent early distribution penalty tax if applicable.

Your second question is whether it is wise to contribute 15 percent if that will put you over the dollar limit. Because of the penalty mentioned in the preceding paragraph, it's not a good idea to contribute more than the dollar limit. However, you might decide to contribute 15 percent of your salary until you reach the dollar limit and then stop for the year. This is known as front-loading your 401(k). You'll get your money in the plan sooner, but you might not get the full employer-matching contributions. Here's why:

Some employers match only during pay periods when the employees make contributions. Other employers match based on the employee's annual contributions regardless of when the employee contributions occur. For example, some employees like to contribute the maximum percentage allowed so they can hit the limit early, others like to contribute an even percentage of pay for the entire year, and others like to contribute large amounts near the end of the year. When the employee contributes during the year shouldn't impact the amount of matching contributions an employee receives, but it could if the employer matches only during the pay periods when an employee contributes.

Assume your employer matches the first 6 percent of pay you contribute, the matching rate is $0.50 per $1.00, and you expect to earn $90,000 during 2001. If you contribute 15 percent of pay, you will hit the $10,500 limit when you have earned $70,000 (15 percent of $70,000). Matching employer contributions will stop at this point if your employer matches only during pay periods when you are contributing. You will have received only $2,100 of matching contributions (3 percent of $70,000), compared to $2,700 if you contributed at least 6 percent for the entire year. In this instance, you should contribute 11.67 percent of your pay so you will hit the $10,500 limit when you have earned $89,974. This will get you within a few dollars of the maximum matching amount.

Question: Do you expect the new Congress to raise the annual contribution limits for 401(k)s and Roth IRAs?

TB: It's reasonable to expect higher 401(k) and IRA limits soon since higher limits were passed with strong Democratic and Republican support during the last two congressional sessions but, unfortunately, were part of larger tax bills which President Clinton vetoed. However, President George W. Bush is not expected to veto any tax-reduction bills that cross his desk.

While I'm pretty confident that limit increases and other retirement plan enhancements should pass this time, I have learned over the years to expect the unexpected from Washington.

Question: What tax benefit will I get from donating to charity from my 401(k) account? Is there any way to make a donation from the account before 59ý without penalty? Please share any tax strategies for charitable giving from your 401(k) or other retirement plans for me.

TB: Charitable giving is not possible with a 401(k). You must take the money out, pay your taxes and then do your giving. Charitable giving, however, is possible with an IRA. I recommend contacting either the development office of the applicable charitable organizations or a good estate attorney to explore your options.

Question: Can a Canadian corporation contribute to a 401(k) plan for American employees working in the United States?

TB: A Canadian corporation is permitted to establish any of the applicable tax-qualified retirement plans for its U.S. employees. The tax rules regarding employee and employer contributions are the same as for a U.S. company that sets up a plan for its employees. The only issue that may be different is how such contributions are treated for Canadian corporate tax purposes.

By the way, I have helped a number of non-U.S. companies set up plans and one of the common mistakes is to attempt to impose non-U.S. logic. Any plan or plans you set up for U.S. employees should be designed to help you attract and retain employees. The best way to do this is to offer a plan that is competitive with what U.S. employers do.

Ted Benna, creator of the first 401(k) retirement savings plan, will answer your most intriguing questions every Tuesday. With over 30 years of experience as an employee benefits consultant, Ted is a nationally recognized expert on benefits issues. He has authored two books, Helping Employees Achieve Retirement Income Security and Escaping the Coming Retirement Crisis, and is President of the 401(k) Association. Ted is a frequent speaker at meetings of 401(k) plan sponsors and participants. His articles and comments have appeared in numerous publications, including The New York Times and The Wall Street Journal.

Read Ted Benna's Biography

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The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

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