401k Contribution Limits: Everything You Need to Know

Your 401(k) is a vital benefit your job offers that allows you to put away money that will enable you to supplement your retirement income later in life. Still, you can't simply put however much money you want into your program. The federal government sets limits on how much you can contribute, and it can even change from year to year, though it hasn't for several years.

The maximum 401(k) contribution limits are set by the IRS. 2017 was the third year that the limit remained stable, at $18,000 per year, but it has increased to $18,500 for 2018. This means that you cannot contribute more than $18,500 of your salary each year to a single retirement plan. If, however, you are at least 50-years-old, you can contribute additional funds called "catch-up" contributions of up to an extra $6,000. This rate has remained the same for the past four years.

These limits are reviewed every October, with the hope being that they will be recalculated upwards based on the current year's inflation rates. Unfortunately, over the past decade, these increases have come at a painfully slow rate. Since 2008, the rate has been adjusted upwards by only $2,000 for the base rate, and $1,000 for catch-up contributions, which have stagnated for some time, remaining at $5,500 for a full six years from 2009 to 2014.

Maximum Allocation

By contrast, the maximum allocation, or the total amount of money you can put into any and all tax-sheltered plans annually, has gone up from $46,000 in 2008 to $55,000 in 2018 for people under age 50, an average increase of two percent per year. For people age 50 and over, the maximum allocation is $61,000 in 2018. With the 401(k) plan the most common type, this isn't the most helpful to many people. The IRS can adjust contribution limits every year, and regardless of the annual limits, you can't contribute more than you actually earn.

Total contributions consist of all money that you or your employer pay into an account. This means that if you contribute $9,000 and your employer matches your contribution, you've reached the $18,000 limit.

Breaking Down Employee Contributions

There are a number of types of employee contributions to retirement plans. These include:

  • Elective Deferral Contributions
  • Designated Roth Contributions
  • After-Tax Contributions

Elective deferrals are also called salary reductions. These are the most common kind of contribution made. They are pre-tax, meaning that they reduce your gross pay before taxes are applied. They're usually expressed as a percentage of pay, but you can designate dollar amounts in some plans. You don't have to report these earnings on your tax return.

Roth contributions are similar, but the deferred amount is taxable. It's taken out of your salary after income tax is collected and isn't excluded from reporting on your tax return.

Other after-tax contributions can be made, usually on an elective basis after your normal salary deferrals. Again, these are reported on your tax return and are collected after your regular income tax is withheld.

Employer Contributions to Retirement Plans

There are also a number of contributions that an employer can make to a retirement plan. Some companies set these as mandatory, while in others they're optional contributions. These include matching contributions and discretionary contributions.

Matching employer contributions are those that are made to your retirement plans and represent a matching portion of that which you put in. These contributions are not taxable income; they may be shown on your W-2 form but aren't reportable. Discretionary contributions, if allowed by the retirement plan, must be equal for all employees covered under the plan. They cannot be made only to certain people, and they are also non-taxable.

Why Doesn't Congress Raise Limits?

A key reason why Congress is reluctant to raise the contribution limits is that it will carry a corresponding decrease in tax revenue. Since most contributions are tax-free, Congress is reluctant to do something that would reduce the amount of tax it collects. In addition, Congress tries to maintain a threshold of increasing contributions by at least $500. Because the consumer price index (CPI) or inflation rate goes up by very small amounts, the threshold hasn't been met.

It should be noted, however, that even with the current limits in place, people are still able to put away a fairly significant nest egg for retirement if they start early and are faithful about contributing.

Roth Contributions, 403(b) and Others

These limits also apply to contributions made to Roth 401(k) plans, as well as other savings plans, including 403(b) plans and Thrift Savings Plans, or TSP contributions. In these cases, employer matches are not included in the limits, allowing employers to match Roth and other plans that exceed the cap, or even the cap and catch-up allotment.

The Cap Isn't the Problem

Despite concerns that some have about the failure to raise limits, for most workers the contribution cap isn't the real problem. The problems that arise for most retirement programs are simply that enough employees don't contribute.

It's surprising how many staff don't contribute to 401(k) plans that are offered. In fact, only 50 percent of employees exceed the median value of $18,433 in their 401(k). This means that despite the fact that the cap hasn't risen, half of all employees don't approach the cap anyway.

Diversify and Contribute

Your best bet, rather than being concerned about the cap, is to diversify your contributions and work hard to approach the maximum allotment. Remember, by contributing to multiple plans, you can put in up to $55,000 per year, which represents a substantial savings by the time you reach retirement age.

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