A 401(k) is a great way to save for your retirement, but because you don’t pay income taxes on the money you contribute (you’ll pay when you withdrawal), the IRS limits how much you and your employer can contribute each year. The annual limits may change, depending on inflation. This article explains the limits for tax years 2022 and 2023. Contribution limits are made up of three factors:
Salary-deferral contributions are the funds you elect to invest out of your paycheck. Catch-up contributions are additional money you may pay into the plan if you are age 50 or older by the end of the calendar year.Employer contributions consist of funds your company contributes to the plan; also known as the “company match” or “matching contribution,” they may be subject to a vesting schedule.
There are two types of limits. One is a limit on the maximum amount you can contribute as a salary deferral. The other limit is on the amount of total contributions, which includes both your and your employer’s contributions. For 2023, you can defer up to $22,500 from your paycheck if you’re under 50. If you’re older, you get a catchup contribution of $7,500, for a total contribution limit of $30,000.
Employer Match
Many employers match at least some of the contributions made by employees. Often this employer match is 3% to 6% of your salary. The IRS restricts the total amount that can be contributed by your own and your employer’s contributions. Total contribution limits for 2022 are the lesser of 100% of your compensation or the following:
$61,000 total annual 401(k) if you are age 49 or younger$67,500 total annual 401(k) if you are age 50 or older
For 2023, those figures are $66,000 if you’re under 50 and $73,500 including catch-up contributions for those 50 and older. In some cases, you can contribute additional amounts to other types of plans; these may include a 457 plan, Roth IRA, or traditional IRA. It all depends on your income and the types of plans available to you.
If You Are Self-Employed
If you are self-employed, you can set up what is often called an “one-participant 401(k)” or “solo 401(k) plan.” It’s also known as an “individual(k) plan.” This savings and investment account allows you to contribute salary-deferral contributions as an employee. At the same time, you can make profit-sharing contributions as the employer.
Types of 401(k) Contributions That the IRS Allows
Many 401(k) plans allow you to put money into your plan in all of the following ways:
401(k) pretax contributions: Money is put in on a tax-deferred basis. That means that it’s subtracted from your taxable income for the year. You’ll pay tax on it when you withdraw it. Roth 401(k) contributions (called a “designated Roth account”): Money goes in after taxes are paid. All of the gain is tax-free; you pay no tax when you withdraw it. After-tax 401(k) contributions: Money goes in after taxes are paid, which means that it won’t reduce your annual taxable income. But you will not pay taxes on the amount when you withdraw it. You might have tax due, at your ordinary income-tax rate, on any interest that’s accumulated tax-deferred on the amount. You can avoid this by rolling over the sum into a Roth IRA.
How Much To Contribute to a 401(k)
Most of the time, you should contribute enough to your 401(k) to receive all employer matching contributions that are available to you. Careful tax planning should be used to decide which type or types of 401(k) contributions would be more beneficial to you (i.e., deductible or Roth contributions).
How To Invest 401(k) Money
You’ll also need to decide how to invest your 401(k) money. One option, which most 401(k) plans offer, is target-date funds. You pick a fund with a calendar year closest to your desired retirement year; the fund automatically shifts its asset allocation, from growth to income, as your target date gets nearer. These funds also have model portfolios you can choose from and online tools to help you assess how much risk you want to take. You can also decide which fund choices would match up best with your desired level of risk.
How To Get Money Out of Your 401(k)
Your 401(k) money is meant for retirement. It’s not easy to take money out while you’re still working, without incurring a steep financial loss. The account is structured that way on purpose; you let the money grow for your future use. There are certain circumstances under which you can take funds out of your 401(k) without paying any penalty. You’ll still need to pay income taxes on the money, since it most likely went into your account on a pre-tax basis. You can start taking withdrawals once you reach 59 1/2 years of age. But there are a few instances when you can take out money earlier without paying a penalty.
Penalty-Free Early Withdrawals
You can take penalty-free withdrawals if you either retire, quit, or get fired any time during or after the year of your 55th birthday. This is known as the IRS Rule of 55. The money in a 401(k) account can also be withdrawn without penalty for a few other reasons; for instance, because you become totally and permanently disabled, for deductible medical expenses over 7.5% above your adjusted gross income, for funds you pay under a qualified domestic relations order, or for funds your beneficiary withdraws upon your death. Your plan may also permit, while you are still employed, “safe harbor” hardship distributions from your 401(k) for certain medical expenses, college tuition, or funeral expenses. The money can also be used for a down payment, repair of damage, or costs related to avoidance of foreclosure or eviction from your primary residence. Keep in mind that you cannot withdraw it to pay your mortgage. Hardship distributions (other than from Roth contributions) are subject to income tax and possibly to the 10% penalty.
When a Withdrawal Penalty Applies
While you can take money out of your 401(k) without penalty for a few reasons, you’ll typically still pay income taxes on it. What if you just want to take the money out to do some shopping before you’ve reached age 59 1/2, or before age 55 if the Rule of 55 applies to you? Well, the IRS will hit you with a 10% penalty on top of taxes. That means that expenses such as a new car or a vacation will cost you extra if you take money out of your 401(k) savings for them. You can also take money out of your 401(k) by taking a loan from your account. The amount is limited to 50% of vested funds, up to $50,000. It must be paid back with interest within five years. You’ll be penalized by missing out on the earnings growth on the borrowed funds. And if the loan isn’t paid back on time, the funds are treated as a regular withdrawal. That means that you’ll pay regular income tax plus the 10% penalty on the borrowed funds.
Past 401(k) Salary-Deferral Contribution Limits
Every few years, the IRS increases the amount that individuals can invest in their plans. Previous years’ limits were as follows:
