The maximum amount that you and your employer can contribute to your 401(k) plan depends on several factors, including the type of 401(k) plan in which you participate, your contributions to other plans, and your age at the end of the tax year. It's important to know the 401(k) limit rules before you allocate funds to your account.
If you and your employer put more money into your 401(k) plan than the IRS allows, you could find yourself paying penalties to the Internal Revenue Service -- or at least scrambling to fix the problem before you get hit with penalties on your tax return.
On the other hand, if you put in less than the maximum amount you and your employer can contribute to a 401(k) plan, you lose out on the tax and investment advantages you could have had by making a full contribution.
If you participate in a 401(k) plan, you should know the answers to the following questions.
1. What's the annual limit on my traditional or safe harbor 401(k) plan?
There are two annual limits to every 401(k) plan: the limit on how much you can defer, and the limit on overall contributions (including the amount your employer kicks in).
By "defer," the IRS means the amount you contribute as an employee. This amount is usually deducted from your paycheck. The annual limit on how much you can defer in a traditional or safe harbor 401(k) plan in 2014 is $17,500. If you are age 50 or older at the end of the year, however, you may be able to defer an additional $5,500 to your traditional or safe harbor 401(k) plan. (Not all plans allow catch-up contributions.)
The overall limit on all contributions for 2014 to a traditional or safe harbor 401(k) plan, including those from both you and your employer, is the lesser of:
- 100% of your compensation
- $52,000, or $57,500 including catch-up contributions
These limits are raised regularly for cost-of-living adjustments.
2. What's the annual limit on my SIMPLE 401(k) plan?
For a SIMPLE 401(k) plan, the annual deferral limit for 2014 is $12,000. That's the maximum amount you can generally contribute as an employee for the year. It's also called a salary reduction contribution, because it reduces the amount of salary you receive and therefore your taxable income.
If you're age 50 or older at the end of the year, you can contribute an additional $2,500 to a SIMPLE 401(k) plan in 2014, if your plan allows it.
With a SIMPLE 401(k) plan, the employer is generally required to match your salary reduction contribution on up to 3% of your compensation. However, your employer may choose to reduce that match limit to between 1% and 3% for up to "two years out of the five-year period that ends with (and includes) the year for which the election is effective," per the IRS.
3. What's the limit if I contribute to multiple retirement plans? If you work for more than one employer, you may be eligible to contribute to more than one type of retirement plan. You could possibly participate in a traditional 401(k), a 403(b), a SIMPLE 401(k), and a SARSEP plan -- all in one year.
That's fine by the IRS, so long as you don't break the annual 401(k) limit rules. Your employers don't know how much you have contributed (or had contributed on your behalf) at other employers, so it's up to you to track your limits and make sure you don't exceed them.
The most you can defer in 2014 is $17,500, regardless of how many plans you have. If you're age 50 or older at the end of the year, the most you can defer is $23,000 -- your individual contribution limit increases even if none of your retirement plans allows a catch-up contribution.
Your deferrals are also limited by the rules for each plan type. In addition, you cannot contribute more than 100% of your eligible compensation.
4. What are "plan-based restrictions" and how do they affect me?
The plan in which you participate may set its own restrictions on elective deferrals. It may have a lower limit than the one set by the IRS. If you are a manager, owner, or highly compensated employee, your plan may be required to limit your elective deferrals to pass nondiscrimination tests.
5. What happens if I have excess deferrals? If your total deferrals are more than the annual limit, you are responsible for notifying the plan manager and asking for a distribution of the difference. This difference is called an excess deferral. The plan must pay it to you by April 15 of the following year. Some plans specify an earlier date.
If you withdraw the excess deferral by April 15, it's almost as if it never happened. There's no penalty, and the withdrawn amount is not reported as income in the year you withdraw it. You have to pay tax on any income earned on the withdrawal.
If you don't withdraw the excess deferral by April 15, you have to pay tax on it in the year of deferral. However, the excess deferral is not included in your cost basis when you eventually take distributions from the plan. As a result, you pay tax twice on excess deferrals: once when you contribute to the plan, and again when you take the distribution.
If the entire deferral stays in the plan, the IRS may determine that your plan is not a qualified plan. That could be a high price to pay for not keeping track of your annual limits on 401(k) plan contributions.