Image: GotCredit, via Flickr.
This article was updated on Dec. 28, 2015.
One reason 401(k) plans are so useful for the millions of workers who have access to them is that they let you save a lot of money for retirement in a tax-advantaged way. There are limits to how much you can save in a 401(k), but they're much higher than the limits for IRAs and similar retirement accounts, and only a small percentage of savers actually max out their 401(k) contributions in any given year. Below, you'll find a simple guide to understand the limits on putting money into your 401(k).
For employees under age 50
The baseline maximum contribution to 401(k) plan accounts applies to workers who are under the age of 50. For 2016, the maximum contribution is $18,000, and the number is subject to annual increases based on changes in the Consumer Price Index. The contribution limit moves in increments of $500, so smaller price changes won't necessarily result in a limit change from one year to the next -- in fact, there was no change from 2015 to 2016, thanks to the low levels of inflation last year. The odds are better that contribution limits will rise in 2017, but that's far from a sure thing at this point..
For employees age 50 or older
Policymakers are aware that many workers get a late start on saving for retirement, whether because of financial hardship or simply because competing priorities make retirement saving take a back seat to more immediate needs. The laws that govern 401(k) plans acknowledge this by allowing what's known as a "catch-up contribution." Those who are 50 or older can contribute an extra amount on top of the ordinary 401(k) limit.
For 2016, the 401(k) catch-up contribution limit is $6,000. That means that in total, those who are 50 or older can generally save as much as $24,000 in their 401(k)s. Like the baseline contribution limit, the catch-up limit is adjusted for inflation and moves in $500 increments.
For all employees who receive employer contributions to their 401(k)
The above limits apply to the money that workers decide to have taken out of their own paychecks and put into the 401(k). But the IRS imposes separate limits on the total amount added to your 401(k), including not only your own contributions but also money that your employer puts in on your behalf.
In total, you can't have more than $53,000 added to your 401(k) for 2016 if you're younger than age 50, or $59,000 if you're 50 or older. To determine whether you're in danger of going over that limit, you have to add up not only the money you put into the plan but also matching contributions, profit-sharing contributions, and any money allocated to your account from forfeited contributions of other workers in the plan. Most of the time, your employer will make sure you never go over that amount.
For highly compensated employees
401(k) plans are required to pass what's known as a discrimination test. The purpose of the test is to make sure that the benefits of 401(k) plans don't just go to workers with high levels of compensation, which, for these purposes, is defined as earning $120,000 or more in 2016, or those who own 5% or more of the business.
The details of the test are complicated, but the general idea is that to pass the test, the average contributions of highly compensated workers as a percentage of salary can't exceed the average for non-highly compensated workers by more than a certain amount. If it does, then the employer must correct the imbalance or else risk having the 401(k)'s tax-preferred status revoked.
The end result is that if a company is in danger of violating the discrimination test, it can force you to take back some of your contributions, even if they were otherwise under the contribution limit. Put another way, lower limits can apply to highly compensated employees depending on what other workers do within the company.
For many savers, the high contribution limits on 401(k) plans can be so large that you might think you'd never be able to max them out in any given year. The more you can save, though, the better your financial position will be as you start to approach your retirement years.
