A 401(k) is a company-sponsored defined contribution account that allows you to save a portion of your paycheck for retirement. 401(k)s are tax-deferred, which means you can take advantage of immediate tax deductions on the full amount of your contribution. However, future withdrawals upon retirement are taxed at your ordinary income rate.
You may assume that because it’s your money and your future retirement, you should be able to contribute however much you want — when you want. That might be the case in a perfect world, but in reality, the government limits how much you can contribute to your 401(k) every year. We’ll cover the 401(k) contribution limits in 2020 and throw in a few historical tidbits so you can make the best decisions about your 401(k) every year.
How Much Can You Contribute to Your 401(k)?
The IRS sets 401(k) contribution limits each year. The contribution limit typically goes up each year (or every few years) to account for inflation. In years of higher inflation rates, these limits usually go up more compared to years with more “manageable” inflation rates. If you’re over 50, you can make additional catch-up contributions as well.
How Much Can You Contribute to Your 401(k) in 2020?
You can contribute up to $19,500 to a 401(k) in 2020. In comparison, the annual limit for contributions to a traditional individual retirement account (IRA) — a tax-deferred retirement savings account — is $6,000 in 2020. Here’s a table that shows how much the contribution limit has changed over the last 15 years.
|Year||401(k) Contribution Limit|
Limits for Employer Match Benefits
Your employer may match your 401(k) contributions up to a certain amount every month. The most common partial match provided by employers is 50% of what you put in, up to 6% of your salary. This means that your employer will match half of whatever you contribute but no more than 3% of your salary total.
In short, you have to put in 6% to get your employer’s maximum match. Let’s say you put in 10% — your employer will still only put in 3%. Note: You company may express how the match is offered a few different ways — but these all mean the same thing:
- 50 cents on the dollar up to 6%
- 50% on the first 6%
- 3% on 6%
The 401(k) contribution limit does not include whatever percentage your employer is willing to match. This means that if your employer does offer to match your contributions, your yearly contribution could be over the standard $19,500 limit.
401(k) Limits for High-Earning Employees
Highly-compensated employees must abide by different rules and regulations that define how much they can contribute. The IRS defines a highly-compensated employee (HCE) as one who either makes more than $125,000 a year and is in the top 20% of compensated employees within the company or someone who owns at least 5% of the company.
HCEs cannot contribute more than 2% than the average amount the lower-compensated employees contribute within the company. For example, if the average lower-compensated employee contributes 3%, the max an HCE can contribute is 5%. These rules and regulations are protected in yearly nondiscrimination tests run by the IRS. If the HCE contributes more than 2%, the excess amount may be refunded to the individual at the end of the year as taxable income. These guidelines are in place to protect 401(k) plans from favoring HCEs.
What are 401(k) Catch-Up Contributions?
You’re eligible to make catch-up contributions to your 401(k) if you’re over 50. It’s designed to help people nearing retirement make extra contributions. The limit in 2020 for this type of contribution is $6,500, which means you can reach an annual 401(k) limit of $26,000. The limit for these contributions also fluctuates like the standard 401(k) contribution limit.
Summary of Contribution Limits
Here are the various contribution limits and thresholds, including the employee contribution limit, catch-up contribution limits and more.
|Type of Contribution Limit||2020|
|Maximum employee 401(k) contribution limit||$19,500|
|Maximum catch-up contribution limit||$6,500|
|Contribution maximum limit (plus catch-up contributions if over 50)||$63,500|
Should You Contribute the Maximum to Your 401(k)?
How much you contribute to your 401(k) depends on your income, lifestyle and ability to contribute. Sure, you’re going to hit your retirement goals faster if you contribute the maximum but you may want to take other things into consideration — even if you have the money to max out your account.
Here are some questions to ask yourself first:
- Are you putting money into other important accounts like an emergency fund?
- Do you have credit card debt or other forms of debt?
- Do you have the right insurance policies — like life insurance?
In other words, you might not want to sacrifice other aspects of your life and wealth for the sake of maxing out your 401(k).
Contribute to the Limit (or not!)
Have no idea how much you should (or shouldn’t) contribute to your 401(k)? Wondering if your company offers a match? First, visit your company’s human resources department to find out more about what the company offers. Your next stop might be with a reputable financial advisor to determine a plan for your 401(k), other retirement savings and your future goals.