401(k) plans give employees the option to divert a portion of salary to a tax-sheltered savings account set up by their employer. There is a limit on how much you can sock away in a 401(k) each year, but the limit is far above the $3,000 IRA cap. For 2004, the cap is $13,000 ($16,000 for taxpayers age 50 or older). Depending on your salary and the limits specified by your employer's plan, you may not be able to contribute the maximum. Most firms allow contributions of between 2 percent and 15 percent of compensation.
A special attraction of 401(k) plans is that many firms offering them sweeten the pot by matching part of the employee's contribution. Matching contributions do not count toward the annual contribution cap. If you quit after just a few years you may have to forfeit part or all of the matching deposits.
The amount you put into a 401(k) plan reduces your salary for income tax purposes, but not for social security tax purposes.
A 401(k) counts as a company retirement plan for purposes of determining your right to deduct traditional IRA contributions, but deferring salary into a 401(k) may boost the size of your allowable IRA deduction. Because 401(k) contributions reduce your taxable salary, they may pull your AGI down to a level that permits you to deduct your IRA contributions.
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