Contributions to a 401(k) can be made in a variety of ways. Typically, a portion of the employee’s paycheck is paid into the plan before federal or state tax is taken out.
Employers can match a percentage of these contributions or make additional contributions of their own. Employees and employers enjoy a degree of freedom over how much they can contribute, up to a set limit. Depending on your salary, age and the type of plan you are enrolled in, your annual limits can range from $12,500 to $55,000. These limits are enforced by the Inland Revenue Service (IRS) and placed on all types of contributions. The IRS updates these limits every year to reflect changes in the cost-of-living. All of the limits mentioned below are for 2018. It is important to note that these limits are only applicable to your 401(k) accounts and do not apply to other retirement funds, such as IRAs. However, if you are also enrolled in an IRA, the amount you can contribute to that IRA may be affected by your participation in a 401(k) plan.
The total amount of contributions made to a 401(k) plan per year must be less than the employee’s entire gross income, or $55,000, whichever is lower. This limitation applies to all 401(k) or other profit-sharing plans under the same employer. This includes an employee’s deferral contributions, an employer’s matched contributions and any additional offerings made by the company. Catch-up contributions, however, are not subject to this overall limit.
Employees who earn more may be subject to more strict limits due to nondiscrimination laws put in place by the Employee Retirement Income Security Act (ERISA). These limitations prevent higher paid employees from deferring large amount of their income, tax-free, until retirement. When they retire, the funds in the 401(k) will be subject to a lower income tax, as most retirees are in a lower tax-bracket than in previous years. This would allow an employee with a high salary to benefit unfairly from the plan. These limitations also help to promote plan enrollment. Tests are conducted by the Employee Retirement Income Security Act (ERISA) to calculate how much an employee with a higher salary can contribute. The calculation is based on how many employees in the company are contributing to their own plans, and to what extent. If everyone is contributing, then the limitation for those in higher income brackets is raised.
Employees have annual limits on how much they can personally contribute to their 401(k) plans. These limits do not apply to employee contributions but go towards the total annual limit discussed above. Different types of 401(k) plans adhere to different contribution limits. It is important to understand these limits and know how they might affect your savings. Traditional 401(k) plans, Roth 401(k) and safe harbor 401(k) plans all adhere to similar employee contribution limits. The total amount of elective deferrals made under these plans in one year is $18,500. The SIMPLE 401(k) plan has a slightly lower limit on annual contributions for employees. The total amount an employee can contribute in one year is $12,500.
Catch-up contributions are available to employees approaching their retirement and want to boost the balance of their plans before the funds are distributed. If you are older than the age of 50 years, you can contribute an additional $6,000 to your 401(k) per year. This is a great way to escalate the growth of your account as you approach retirement.
Your limitations may be lower depending on the specifics of your 401(k) plan. Make sure you clarify your limitations with your employer, so you can get the most of your plan and avoid any penalties. It is important to adhere to your 401(k) contributing limits. If you exceed your annual limit you must fix the error. If you do not fix the error by April 15th of the following year it can result in a double taxation on the excess funds. Talk to your employer if you think you have exceeded your limit.
In addition to the limits placed on the employee, the employer must also adhere to annual contribution caps for their 401(k) plans. Companies can contribute in a variety of different ways. They can match an employee’s deferred electives, contribute profits or fund the plan with other items, such as company stock. There are two limits that are associated with an employer’s compensations: a total contribution limit and a matching contribution limit. These limits are outline below.
Total Employer Contributions
The total amount an employer can contribute to an employee’s 401(k) per year is $36,500. This limit only applies to an employer’s contributions, not the employee’s, and includes any matched contributions made in that year. The employee contribution limit is subject to the total annual contribution limit mentioned above. For example, if an employee contributes the maximum amount he or she is allowed per year ($18,500), and an employer contributes the maximum they are allowed per year ($36,500), the total annual contribution will be within the allowed limit of $55,000. Catch-up contribution are not subject to this limit and can be made in addition to the $55,000.
Matching Contribution Limits
There are also limits on the compensation, or income, allowed to be used when calculating an employer’s matched contributions. If an employer decides to match an employee’s 401(k) contribution by using a percentage of their income and their elective deferrals, they can only use $275,000 of the employee’s income to calculate the amount. For example, if your annual income is $300,000, your employer can only use $275,000 to calculate the matched contributions made to your plan. Again, this limit is to protect those in higher income brackets from unfairly profiting from their 401(k) plans.
Specific employee contribution limits are set for SIMPLE 401(k) plans. An employer can only match 3 percent of an employee’s pay when contributing dollar-for-dollar into their plan. Alternatively, they can only contribute 2 percent of non-elective contributions for each employee that is eligible under the plan.