How Much You Can Contribute to a 401(k)

Understanding How 401(k) Limits Work

401k Contribution Limit Guide
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A 401(k) retirement plan can be a very effective way to build wealth without diverting a big chunk of your money toward taxes. Under these plans, any money you contribute is deducted from your taxable income, thus potentially saving you hundreds of dollars in taxes each year. 

The U.S. Congress, understandably, put limits on the amount of money you can contribute each year. Otherwise, a person with a very high income could put millions upon millions of dollars in their 401(k) plan each year, costing the government significant revenue. By placing limits on contributions, Congress can ensure that it is the middle class that benefits most from the tax advantages of 401(k) plans. 

The Three Types of 401(k) Contribution Limits

Calculating how much money you are allowed to put into a 401(k) can be a bit tricky. As a result, you have to be extremely careful not to exceed the 401(k) contribution limits in effect in any given year. What makes the limits somewhat more complicated than those on a Traditional IRA or Roth IRA is the fact that, for all intents and purposes, there are three different types of limits placed on your 401(k) contributions.

  • The Elective Deferral 401(k) Contribution Limit represents the amount of money that the owner of the 401(k) account can contribute from his or her own paycheck. In 2018, this part of the 401(k) limit was set at $18,500. 
  • The Catch-Up 401(k) Contribution Limit represents additional money that workers over 50 years old can contribute toward their retirement savings. As of 2018, this figure is set at $6,500. Thus, a person 50 or over can contribute as much as $25,000.
  • Additional 401(k) Contribution Limits represent a "catch all" rule. Basically, the grand total of all elective deferral contributions, plus catch-up contributions, plus any money added to the account by the employer in matching funds or bonus systems, etc. cannot exceed the lesser of 100% of your compensation or $55,000 in the year 2018. 

That last bit is important. Essentially, it means that if you are under 50, the most money you can get into a 401(k) in any given year is $55,000. Of that, only $18,500 can come from your own contributions. The other $36,500 must come from your employer. Very few employers offer generous enough 401(k) packages to take advantage of those kinds of limits.

What Happens If You Exceed the 401(k) Contribution Limits

If you are fortunate enough to be able to max out your 401(k) contributions, it can be a little challenging to determine how much to put aside each month without inadvertently putting in too much. The easiest way is to take $18,500 and divide it by your gross income. That will determine how much, on a percentage basis, will be taken out of each paycheck and directed toward your 401(k) plan. If your income goes up during the year, you will have to adjust this figure accordingly. 

If you contribute more money to your 401(k) account than you are permitted, you have until April 15th to tell the plan to return the cash to you. This overpayment is referred to an excess deferral. If you received a tax deduction, you will have to give it back upon withdrawing the excess deferral but you shouldn't be subject to the additional 10% early withdrawal penalty

It is your responsibility to catch excess 401(k) contributions, not your employer's. If you don't remove the excess before the tax filing deadline in the year in which the error is made, you will face stiff penalties, a form of double taxation, and might even have your entire retirement plan reclassified as non-qualified, which would have enormous financial implications if you have built a decent-sized nest egg. 

The 401(k) Contribution Limits for High Earners

If you qualify as a so-called highly compensated employee, which means making more than $120,000 from your employer in 2018, you might have a lower 401(k) limit than you otherwise would. This could happen if your employer's plan is considered "top heavy." In simple terms, a plan is considered "top heavy" if the highest earners of the company (anyone earning more than $175,000) are making more than 60% of the total contributions. Congress wanted to make sure 401(k) plans weren't just used to benefit higher-ups in the management structure. 

Ask Professionals for Help

The rules and regulations surrounding retirement plans are notoriously complex, talk to a Retirement Specialist, Tax Attorney, Qualified Accountant, and/or Human Resources if you need help. If you make a mistake, it could significantly hurt your family's finances. If you think you might have done something wrong, or are in danger of violating one of the provisions governing your retirement plan, talk to the right people and get the problem solved as soon as possible.