If you’re getting serious about saving for retirement, a 401(k) plan will be one of the first instruments of investment you’ll look at. This workplace retirement plan is a tax-advantaged retirement account allowing you to contribute towards retirement savings while saving on tax. Given the tax advantages of a 401(k), the government limits how much you can contribute to this account every year. Each year, the IRS will announce 401(k) contribution limit increases based on inflation, cost-of-living adjustment, and other factors.
In this article, we’ll talk about the 401(k) contribution limits for 2023, how much of your salary you can and should put toward your 401(k), and what happens if you go over the contribution limits.
401(k) contribution limits in 2023
A traditional 401(k), which gives you a tax break on the dollars you’re putting into the account, and a Roth 401(k), which allows for a tax-free income in retirement, both have the same contribution limits. However, it’s important to remember that your total contributions must not exceed your annual compensation at the company that holds your plan.
The 401(k) annual contribution limit for 2023 is $22,500 for employee contributions and $66,000 for combined employee and employer contributions. If you’re 50 or older, you’ll have an additional $7,500 available as a catch-up contribution limit, meaning your total contribution limit will be $30,000.
If you have both a traditional and a Roth account, the total contribution across all your accounts must be less than the contribution limit. If you’ve contributed the maximum of $22,500 into your traditional 401(k), you cannot contribute to your Roth 401(k) and vice versa.
IRA contribution limits are separate, and how much you put into your 401(k) does not impact your IRA contributions.
The 401(k) employer match
The 401(k) is an exceptional tool for retirement savers because of the free money you can earn from an employer match. Many employers will offer matching contributions for your contribution amount; when you put money towards your 401(k), your employer will match a portion. This percentage will usually be agreed upon in advance, so the more you contribute towards your 401(k), the more your employer matches, and the more free money you can put towards your retirement.
The employer match doesn’t count toward your individual limit. There are combined limits to the 401(k), however, that your combined contributions must not go over. 2022 the limit was $61,000 for combined employee and employer contributions. In 2023, that limit was increased to $66,000.
Companies also have the option of nonelective contributions. A nonelective contribution is when a firm contributes to an employee’s 401(k) regardless of whether and how much the employee has contributed. While some companies offer these nonelective plan contributions instead of, or in addition to, matches, they’re pretty uncommon. These will count towards the maximum contribution limit as well.
Traditional vs. Roth 401(k)
The contribution limits for traditional, and Roth 401(k) accounts are the same. However, if you have multiple accounts, the combined contributions across all accounts must be less than the annual limit. Like traditional IRAs (Individual Retirement Accounts) and Roth IRAs, the main point of difference between a traditional 401(k) and a Roth 401(k) is in the way the money is taxed.
This 401(k) is a tax-deferred account with pre-tax contributions. That is, the money you put into the 401(k) is not taxed right now but when you withdraw during retirement. This can benefit people with a high tax rate now but expect that tax rate to be lower in retirement. For example, if a taxpayer is currently in a 35% tax bracket but expects that their income will place them in the 24% tax bracket in retirement, it may make more sense to pay taxes in retirement through a traditional 401(k).
Like the Roth IRA, the Roth 401(k) takes after-tax contributions, allowing your money to grow tax-free. This is great for people who intend to put a lot of money into this retirement account and anticipate a high level of growth. You can withdraw contributions and earnings from a Roth 401(k) if you’re at least 59 1/2 and have owned the account for five years. You’ll also be required to take minimum distributions once you turn 72. You may want to talk to a financial advisor to see which option is right for you.
Can you contribute your entire salary to a 401(k)?
The 401(k) plan doesn’t limit how much of your salary you can contribute. However, since there is a contribution limit of $22,500 for the year 2023, you can contribute as much of your pay as you like until that point and an additional $7,500 if you’re 50 years or older. If your earnings are below $22,500, you can contribute your entire salary towards the 401(k).
Contributions for highly compensated employees
There is typically no income limit on 401(k) contributions. However, the Internal Revenue Service (IRS) can, in some instances, impose contribution limits on highly compensated employees, defined as:
- An individual who either owned more than 5% of the interest in a business at any time during the year or the preceding year, no matter how much they were paid.
- An individual who received over $135,000 from the business in the preceding year in 2022, or $150,000 in 2023, and, if the employer ranks employees by compensation, was in the top 20%.
For employers who sponsor 401(k) plans, the IRS has a test to see if there are disproportionate contribution levels among workers. That being the case, the employee contribution level for highly compensated employees can be lowered.
What percent should you contribute to a 401(k)?
Financial experts set several benchmarks to see how well you’re doing in retirement planning and how much more you need to contribute to meet specific age-specific retirement goals. For example, some experts recommend putting between 10 and 15 percent of your gross income towards retirement in your 20s and 30s and, if you’re behind during your later years, anywhere from 15 to 25 percent.
According to a Fidelity model of retirement savings benchmarks:
- By the time you’re 30, you should have saved 1x your annual salary.
- By the time you’re 40, you should have saved 3x of your annual salary.
- By the time you’re 50, you should have saved 6x of your annual salary.
- By the time you’re 60, you should have saved 8x of your annual salary.
- And by the time you’re 67, you should have saved 10x your annual salary.
Depending on how old you are, how much you’ve already saved, and how much you can afford to spare from your current income, you can calculate the percentage that makes sense for your financial situation and personal finance goals.
What happens if you exceed the contribution limit?
If you’ve accidentally exceeded the contribution limit on your 401(k), you could incur costly penalties—a 10% fine plus any unpaid income taxes on the excess contributions. While there are typically systems that prevent this, over-contributions can happen if you switch jobs midyear and do a 401(k) rollover or have multiple 401(k) plans.
If you notice that this has happened, you must notify your company’s HR or payroll department immediately. The plan administrator will adjust your W-2 to include the excess contributions as part of your taxable income. Excess contributions can be reported on Form 1099-R when filing your taxes.
The bottom line
The 401(k) is an excellent vehicle for retirement savings, regardless of whether you opt for a traditional 401(k) or the Roth 401(k). Plus, with the employer match offering free money, there’s no reason not to make the maximum contribution possible.
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