401k and 403b Before-Tax Limits
The IRS has set limits on how much an individual can contribute each calendar year to their employer-sponsored retirement plans. For 2023, the max contribution to a 401k is $22,500 up from $20,500 in 2022. There is an additional “catch-up” contribution of $7,500 for those over 50 years old. These limits are up $2,500 and $1,000 respectively from 2022.
For the average person, the maximum contribution may be out of reach initially, but investors should be aware of these upper limits.
“All Sources” Contribution Limit
After reaching the before-tax contribution limit of $22,500, the buck does not have to stop there. The IRS has set a total “all sources” plan contribution limit of $66,000 per year in 2023. This amount is increased to $73,500 per year for those 50 or older. This is up from $61,000 and $67,500 from 2022.
Contributions from All Sources include:
- Before-Tax Contributions
- Company Match Contributions
- After-Tax Contributions
401(k) and 401(b) Basics
401(k)s and 403(b)s allow an employee to contribute before-tax dollars into an employer-sponsored retirement plan. Paycheck deductions allow you to place tax-free earnings into investable funds to hopefully build a nest-egg for retirement.
The tax advantage of these types of retirement accounts is two-fold. First, it allows your money to grow at a faster rate because you are able to contribute more money without having Uncle Sam take his cut first. Second, it lowers your taxable income which will bring down your tax-liability come filing time.
Hopefully, a representative has gone over the basics of how your plan works. Companies have been notorious for briefly skimming over plan details during job orientations. This often leaves employees in the dark on the finer details and rules of their retirement plan.
By the end of this article, you will get a clearer picture of your 401(k) rules and how to maximize your savings!
Company Match Programs
Some companies offer partial or full match contributions up to a certain percentage of your salary. Talk about handing out free money.
Examples may include a 50% match of up to 6% of your salary. Or 100% match, up to 4% of your salary. Discretionary matches can be used to raise those percentages based on company performance.
Does the company match money count toward my 401(k) limit?
As stated above, the company match money does not count toward the $22,500 limit of before-tax money. Company match dollars will count toward the all sources limit of $66,000.
Must-know Rules About Your 401(k) Company Match Program
Companies will often put a few stipulations on the match programs. Make sure you understand these so you are not missing out on money:
- Becoming Vested: Companies may put a minimum time limit that you must remain working as their employee before actually keeping the company match money. My company has set a 3-year rule. Quit before that date and they take their contribution portion out of your 401k. Ouch.
- Obtaining the Full Match Amount: It may not be financially possible to hit the max contribution to a 401k of $22,500 each year. There is nothing wrong with that, but do yourself a favor and make every attempt to put in enough to get the full match amount that is offered. It will allow you to see great savings by having your employer max out their portion of your 401(k) match.
- Not Contributing the Minimum Deduction: Many company match programs spread out their contributions throughout the entire calendar year. My company requires a minimum of 1% self-contribution for each pay period in order for them to make the full match. An employee electing a large 401(k) paycheck deduction early in the calendar year and then switching to 0% near the end of the year will miss out on money. Look into your plan details for this information.
401k After-Tax Contributions
Before-tax contributions + Company Match Contributions + After-tax contributions must not exceed $61k.
After-tax contributions are not allowed by all Company 401(k)s. Those that do offer after-tax contributions can really help build-up a rather large nest-egg in a short amount of time.
Should You Contribute After-Tax Dollars to a 401(k)?
The short answer is, it depends.
Pros of After-Tax 401(k) Contributions
All Your Money in One Place
For those investors that want a simpler approach to retirement income, investing after-tax dollars into a 401(k) may not be a bad option. It allows those wanting to save more than the $22,500 max contribution to a 401k a chance to keep all their retirement savings in one place.
Only Taxed Once
Also, because you have already paid taxes on this money through payroll, you will not be taxed when withdrawing it during retirement like your pre-tax amounts in your 401(k).
Roth IRA Conversion
There are some pretty cool tax plays you can make by rolling over your after-tax 401(k) contributions into a Roth IRA. It is a good read on some of the details for that particular rollover tax play.
Cons of After-Tax 401(k) Contributions
There are also negative aspects of investing after-tax dollars into a 401(k). Below are a few reasons why placing after-tax dollars outside of your company-sponsored plan may be a better choice for you.
Limited Investment Choices
Employer-sponsored 401(k) plans tend to extremely limit your choice of funds to invest in. My 401(k) has a good variety ranging from target-date, stock, and bond funds to choose from. In total, I have approximately 20 different funds where I can allocate my money.
On the other hand, my brokerage account gives me access to thousands of different choices to invest my money. I enjoy the variety, but others may see this as overwhelming.
Establishing an Emergency Fund First
Before you consider trying to reach the max contribution to a 401k you should first establish an emergency fund. Life happens to us all! Having access to some of your savings is a huge advantage. Brokerage accounts allow more liquidity than investing into a 401(k) where your money can’t be accessed until 59 1/2 years old without early withdrawal fees.
Complicated Tax Conversions
The Roth IRA conversion tax-play mentioned above can end up being very tax-friendly, but it comes with some headaches. A tax professional would be helpful in determining the exact portion of your after-tax contributions to rollover. This will ensure that you save the most amount of money and do not incur any penalty fees in the process.
Can I Over-Contribute to My 401(k)?
Yes, it is possible to over-contribute to your 401(k). However, it is very unlikely because most employer-sponsored plans will not allow deductions to are made past the max contribution to a 401k.
Most Common Way People Over-Contribute to their 401(k)
The biggest way employees over-contribute to their 401k is by changing jobs at some point during the year.
Plan administrators do not communicate between different companies and therefore it is on you to ensure you do not over contribute during that calendar year.
The before-tax and “all sources” contribution limits are inclusive of all jobs that you hold for that particular year. The numbers do not start over if you start a new position at another company.
Getting A Raise
Not all plans will stop you from over-contributing before-tax dollars to your 401(k). If you fall into this category, your paycheck deductions should be carefully calculated if you are planning on “maxing out.”
Pay raises throughout the year can bring you in over the maximum contribution limit if you have set up your payroll deduction on a percentage basis.
Payroll deductions may have to be decreased to keep you below the limits.
What Happens If I Over-Contribute to My 401(k)?
The first step would be to contact your plan administrator. Let them know you have made an excess deferral and that you would like it to be corrected.
This only can be changed if the correction is made before tax filing. They will remove your excess contribution and pay it to you like your ordinary taxable income.
A corrected W-2 will need to be issued at this point. Also, if any interest was made from the excess contribution, it will be paid to you in the form of a 1099-R that will need to be filed at tax time.
What Happens if I Notice My 401(k) Over-Contributions After I File My Taxes?
Unfortunately, a mistake like this will cause you to pay taxes twice on the over-contribution.
The IRS will force you to pay back taxes for the year in which the over-contribution occurred. Then, you will need to pay taxes on for the current year when the plan administrator makes the correction.
Double Whammy! Ouch!
Be smart and carefully plan your contributions. The work that involves correcting over-contributions to a 401(k) is not worth the headaches.
List of 2023 Max Contributions to 401k
- Before-Tax Limit for 2023 is $22,500
- Additional $7,500 Catch-up for a total of $30,000 for those 50 or older
- All sources Income of $66,000
- All sources Income of $73,500 for those 50 or older
401k Contribution Review
- Before-Tax + Company Match + After-Tax cannot exceed “All Sources” Limit
- Obtain the maximum Company Match each year by knowing the Plan Rules.
- Decide if After-Tax Contributions are in your best interest.
- Fix Over-Contribution Amounts before Tax Filing, even better to not do it.
Knowing and following the simple rules for maximum contributions to a 401k will allow your nest-egg to achieve its maximum potential. Compound Interest can grow your retirement account into a behemoth, but it needs time. Start saving into your 401(k) immediately and watch it grow!