Your 401(k) plan is likely one of the largest investment accounts you have because you contribute money from every paycheck toward your retirement. You can save as much as you want overall in a pretax 401(k), but you're limited as to how much you can contribute every year. If your employer also contributes to your 401(k), those contributions are also limited, and the salary for employer matching contribution purposes is capped at a certain amount.
For 2018, you can contribute up to $18,500 to your 401(k) from your pretax earnings. In 2019, the contribution limit will increase to $19,000. If you're over age 50, you may qualify to make catch-up contributions of up to $6,000.
What Is a 401(k)?
A 401(k) is an employer-sponsored retirement account to which your contributions are added pretax, meaning they come from your paycheck before the taxes come out. This allows you to reduce your taxable income now, and thus reduce your tax bill, and defer assessment of the taxes on that income until you start getting distributions when you retire. These contributions, also called "elective deferrals" by the IRS, are a percentage of your paycheck.
You choose how much you want taken out every pay period, such as 5 percent or 10 percent, and your employer will take that percentage right off the top, before anything else comes out, and deposit it into your account, where it will grow interest until you're ready to withdraw it when you retire.
How Does 401(k) Matching Work?
Your employer may offer 401(k) matching, which allows you to put away even more money for retirement. Employer matching options vary, but generally, it means the employer will contribute to your 401(k) on your behalf the same amount you contribute, up to a certain amount. For example, if your employer offers 4 percent 401(k) matching and you personally contribute 10 percent of every paycheck, your employer will match that amount up to 4 percent. If your paycheck before taxes is $1,000, your contribution will be $10, and your employer's contribution will be $4, for a total contribution of $14.
401(k) Contribution Limits
In 2018, you can't contribute more than $18,500 in pretax earnings to a 401(k). That number is going up to $19,000 in 2019. This means that all the money that comes out of your paycheck to go into your 401(k) cannot exceed $18,500 in 2018 or $19,000 in 2019. That contribution limit applies only to your contributions; it doesn't apply to any matching or other contributions your employer makes into your plan. So if you make $185,000 per year before taxes, the maximum you can contribute to your 401(k) is 10 percent. If you set up a larger percentage, your plan will stop taking money out of your check after you hit the $18,500.
Employer Contribution Limits
If you have employer matching or any other type of employer contributions, those are also limited. While you can only contribute up to $18,500 in 2018 or $19,000 in 2019, all contributions to your account from any source cannot be more than $55,000 in 2018 and $56,000 in 2019. As a result, if you end up contributing $18,500 from your pay in 2018, your employer can't contribute more than $36,500 into your account. The only exception to these rules is if you're entitled to catch-up contributions.
Catch-Up Contributions for Employees 50 and Older
Both employer contribution limits and your own contribution limits may be increased slightly if you're age 50 and over. This extra contribution amount is called a catch-up contribution because it permits older employees to set more money aside for retirement as they get closer to retirement age. If you're 50 or over, you can contribute up to $6,000 extra into your 401(k) on top of the contribution limit. This figure is the same in 2018 and 2019. If you have a SIMPLE 401(k), that amount is reduced to $3,000. Thus, if you're 52 years old in 2018, you can contribute $18,500, plus $6,000, for a total of $24,500 in contributions for the year.
Annual Compensation Limits on Employer Matching
Employer matching has one more limit beyond the contribution limit, designed to curb matching contributions for high earners. In 2018, if an employee makes more than $275,000, the employer's matching contributions are limited to a percentage of $275,000.
For example, if you make $300,000 in 2018 and you contribute 3 percent to your 401(k) and your employer matches that percentage, you can contribute 3 percent of $300,000, but your employer may only contribute 3 percent of $275,000.
Your employer will either reduce the amount it contributes per pay period, or it will contribute the full amount until your salary reaches the limit, and then contributions will stop. So if your employer matches you at 3 percent on $300,000 per year, it would be $9,000 per year without the limit ($750 per month), but with the limit, it can only contribute $8,250 that year (3 percent of $275,000, which comes to $687.50 per month). Your employer can either contribute $750 per month until it hits $8,250, or it can pay $687.50 per month all year.
In 2019, the compensation limit will go up to $280,000.
Going Over the Contribution Limit
Some people do end up going over the contribution limit during the year. The IRS calls the amount over the limit "excess deferrals." If at the end of the year, you realize you over-contributed, you must notify your plan of the over-contribution and get the money back, plus any interest it earned, by April 15 of the following year. You'll receive a Form 1099-R from your plan reporting the excess contributions, and you'll have to submit the form with your taxes.
For example, if you realize you contributed $20,000 in 2018 and you're under the age of 50, you must notify your plan administrator and get the $1,500 excess returned to you with any interest it earned before April 15, 2019. If you manage this, you'll have to include the withdrawal as part of your gross income for 2018, but you won't be subject to the 10 percent early withdrawal penalty.
If you withdraw the excess after April 15 of the following year, you'll end up being taxed twice for it: once in 2018 and once again when you eventually withdraw it. If you leave it in the plan, it may cause your entire plan to lose its 401(k) qualification. All in all, it's best to withdraw the excess as soon as possible, and before April 15.
Pretax vs. Roth 401(k)
Some employers offer a Roth 401(k) plan. Much like a Roth IRA, but unlike a traditional 401(k), Roth 401(k) plans allow you to contribute post-tax dollars, so your contributions come out of your check after your taxes. That means that when you get distributions from the Roth after you retire, you don't have to pay taxes on them because you already did. You'll only owe tax to the extent of any interest you earned in the account. Unlike a Roth IRA, you can contribute to a Roth 401(k) regardless of how much income you have, but the plan must be employer-sponsored because it is a 401(k). The Roth 401(k) has the same contribution limits as a traditional 401(k).
- IRS: Retirement Topics - Contributions
- IRS: 401(K) Plans - Deferrals and Matching When Compensation Exceeds the Annual Limit
- IRS: Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits
- IRS: Retirement Topics - Catch-Up Contributions
- Kiplinger: What Is a 401(k) Retirement Savings Plan?
- IRS: Roth Comparison Chart
Rebecca K. McDowell is an attorney focusing on creditor and debtor law. She has a B.A. in English and a J.D. She has written finance and tax articles for Pocketsense and eHow.