Explore the Monetary Capabilities of 401(k) Contributions
Explore the Monetary Capabilities of 401(k) Contributions
Many employers offer their workforce a 401(k) scheme as a tool to help them save for their golden years. Given that it's a qualified plan, it falls under the jurisdiction of regulations established by the 1974 Employee Retirement Income Security Act (ERISA). One rule under ERISA limits income to ensure the plan doesn't unfairly favor well-paid workers over their less privileged colleagues.
Most individuals will not be impacted by this regulation, and even those who do should experience minimal repercussions, which won't hamper their retirement savings strategy much.
401(k) income limits
Regardless of one's income level, you can contribute to a 401(k). However, the Internal Revenue Service (IRS) establishes limits on the amount of income considered when determining the employer's matching contribution.
For 2025, the IRS sets the cap on eligible compensation for 401(k) contributions at $350,000. This is an increase from the 2024 limit of $345,000. The IRS adjusts this limit annually to reflect changes in the cost of living.
It's critical to note that this limit pertains to total compensation, which encompasses employer contributions to a 401(k) plan and not just salary.
Those earning above the limit aren't precluded from contributing. Rather, compensation exceeding the limit isn't eligible for contribution.
Employees earning more than the limit can still contribute the maximum salary deferral to their employer's 401(k) plan. However, the employer's matching contribution will only apply up to the limit.
For example, if you earn $500,000 in 2025 and your employer offers a 5% match on your 401(k) salary deferrals, you can contribute $23,500. Your employer match would be $17,500, though, instead of the full $25,000, or 5%. This is due to the $350,000 compensation limit for 2025. Even though 5% of $500,000 is $25,000, 5% of $350,000 is only $17,500.
In infrequent situations, such as when 401(k) plans are poorly drafted, employees' own contributions may be affected differently by income restrictions. If the plan allows employees to defer salary until they reach the annual income limit, they will be unable to contribute significantly during the last part of the year after surpassing that limit. If this applies to your plan, engage your HR department to revise the wording to permit year-round contributions. Before then, ensure you contribute early in the year.
401(k) contribution limits
401(k) plans are subject to various contribution restrictions.
Firstly, there's the annual employer salary deferral limit, which amounts to $23,500 for 2025 (up from $23,000 in 2024). Employees aged 50 and older can contribute an additional $7,500 in both 2024 and 2025. From 2025, workers aged 60-63 can make a catch-up contribution 50% higher than the regular limit, thus increasing their maximum catch-up contribution to $11,250.
Secondly, there's the overall contribution limit, which comprises both employer and employee contributions. In 2024, it's $69,000 or $76,500 for employees aged 50 and above. The 2025 limit is $70,000 for employees aged 50-59 and 64 and above, as well as $81,250 for those aged 60-63. Employer contributions are capped at 25% of an employee's salary.
Highly compensated employees
Additional contribution restrictions affect highly compensated employees in line with IRS and your 401(k) plan guidelines.
A highly compensated employee (HCE) satisfies at least one of these conditions:
- They hold more than 5% of the company sponsoring the plan anytime during the last year. This 5% ownership includes personal holdings, along with those of immediate family members and grandchildren working for the business.
- They exceed the annual compensation threshold specified by the IRS. The limits are $155,000 for 2024 and $160,000 for 2025. Certain 401(k) plans may also stipulate that the individual should rank among the top 20% of employees when it comes to compensation.
In order for the plan to remain ERISA-compliant, HCEs cannot contribute more than 2 percentage points above their average salary compared to non-HCEs. Therefore, if the average non-HCE contributes only 5%, the HCE group cannot contribute more than 7% of their combined salary.
This can make contributions planning challenging since the limit relies on the contributions and compensation of other employees. Also, if you fail to contribute in the calendar year, it eliminates the opportunity to do so despite not knowing your actual contribution limit until the early part of the following year.
The conclusion of work doesn't imply the cessation of expenses. What amount ought to be saved for an outstanding retirement?
The recommended strategy is to contribute up to the standard contribution limit, and let the plan administrator decide if you've excessively contributed. If you have, you'll receive your excess contribution back, but you'll be liable for income taxes on the whole sum - both the principal and the earnings.
While there are income restrictions on the amount you can contribute to a 401(k) plan, most investors won't experience significant repercussions. However, it's crucial to comprehend the regulations and know how to act if your plan is disadvantaged by its writing, to ensure you fully benefit from your employer's 401(k) plan.
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Despite the income limits set by the Internal Revenue Service for employer matching contributions in 401(k) plans, individuals can still contribute up to the annual salary deferral limit, which increases from $23,000 in 2024 to $23,500 in 2025 for employees under 50. (401(k) contribution limits)
Retirement savings strategies should consider contributing up to the standard limit, as exceeding it could lead to income tax liability on both the principal and the earnings, which may be returned as an excess contribution. (Retirement savings strategy)