Tax Deferred Contribution Limits

1. Understanding Tax-Deferred Accounts (e.g., 401(k))

Tax-deferred accounts like 401(k) plans allow employees to save for retirement by contributing a portion of their salary before taxes are applied. These contributions reduce the employee's taxable income for the year, resulting in immediate tax savings. The investments grow tax-deferred until withdrawals are made during retirement, at which point they are taxed as ordinary income.

2. Contribution Limits

The IRS sets annual limits on how much an individual can contribute to tax-deferred accounts. These limits are in place to ensure fairness and to prevent high-income individuals from sheltering too much income from taxes.

• Elective Deferral Limit (Employee Contribution Limit): This is the maximum amount an employee can contribute to their 401(k) plan in a given year.

  • For 2023: $22,500
  • Catch-Up Contribution (Age 50 and over): An additional $7,500, bringing the total to $30,000.

• Total Contribution Limit (Employee + Employer Contributions): This is the combined maximum limit for all contributions made to the plan, including employee contributions, employer matching, and any other employer contributions.

  • For 2023: $66,000
  • Including Catch-Up Contributions: $73,500

3. How Limits are Applied

• Employee Contributions: Limited to the elective deferral limit. Any contribution strategy should ensure that the employee's total annual contribution does not exceed this limit.
• Employer Contributions: Combined with employee contributions, should not exceed the total contribution limit.
• Excess Contributions: If contributions exceed the limits, penalties may apply, and excess amounts must be corrected.

4. How is it possible to hit the full limit (employee + employer)?

Understanding the Total Contribution Limit

The total contribution limit for tax-deferred retirement accounts like 401(k)s includes both employee and employer contributions. For 2023, the IRS total contribution limit is:

• Under Age 50: $66,000
• Age 50 and Over: $73,500 (includes $7,500 catch-up contributions)

Reaching the Total Limit

To hit the full total contribution limit, both the employee and employer need to maximize their contributions:

• Employee Contributions (Elective Deferrals): Limited to $22,500 (or $30,000 if age 50+).
• Employer Contributions:
  • Can include matching contributions, non-elective contributions, and profit-sharing contributions.
  • Not limited by the employee's elective deferral limit but subject to the total contribution limit.

Possible Scenarios to Hit the Total Limit:

1. High Income and Generous Employer Contributions:

   • Employee contributes the maximum elective deferral ($22,500).
   • Employer contributes the remaining amount up to the total limit ($43,500).
   • Common in companies with profit-sharing plans or generous matching policies.

2. After-Tax Contributions (Not Roth):

   • Some 401(k) plans allow after-tax contributions beyond the elective deferral limit.
   • These contributions, combined with employer contributions, can help reach the total limit.
   • Note: After-tax contributions can be rolled over to a Roth IRA (Mega Backdoor Roth).

Important Considerations:

• Plan Limitations: Not all employer plans allow contributions beyond the elective deferral limit.
• Non-Discrimination Testing: Highly compensated employees may be restricted in contributions to ensure fairness.
• Realistic Scenarios: While theoretically possible, hitting the total limit is less common and depends on specific plan provisions.