In this article:
- How the 401(k) Compensation Limit Works
- 401(k) Contribution Limits for 2022
- How to Maximize 401(k) Benefits
Is it possible to earn too much money to contribute to a 401(k)? Strictly speaking, it's not. If your employer offers one, you can contribute to a 401(k) regardless of your salary. But if you earn more than the IRS compensation limit for 401(k) plans, some of your salary might not be eligible for an employer match.
How the 401(k) Compensation Limit Works
In 2022, you can contribute up to $20,500 to your employer's 401(k) plan no matter how much you earn. However, the IRS limits the amount of income on which you can receive an employer match to $305,000.
Here's how it works: Suppose your annual salary is $500,000. Your employer's policy is to match 100% of your contributions up to 5% of your total compensation. In this scenario, you can contribute the IRS limit of $20,500, and your contribution limit is not affected by income. You can also take advantage of your employer's 100% match, but not on 5% of your entire $500,000 in income. Because the IRS limits the amount of income your employer can match, you can only receive matching contributions on 5% of $305,000, or $15,250.
The IRS 401(k) income limit applies only to employer contributions—not employee contributions. The employee contribution limit set by the IRS does not take income into consideration: It's a set $20,500, regardless of how much you make.
401(k) Contribution Limits for 2022
The IRS adjusts contribution limits yearly based on the cost of living. For 2022, the IRS' 401(k) contribution limits are as follows:
- Employees may contribute up to $20,500 with an additional $6,500 catch-up contribution for employees 50 and older.
- Total employer and employee contributions cannot exceed $61,000 or 100% of the employee's compensation (plus the $6,500 catch-up contribution if applicable).
How to Maximize 401(k) Benefits
Although the IRS limits the amount your employer can contribute to your 401(k), taking advantage of tax-deferred retirement savings through your employer is often a great investment, especially if your employer offers matching funds. Here are a few tips to consider if you're thinking of contributing to a 401(k):
Max Out Your Match
If you can swing it, try to contribute enough to get the maximum matching contribution your employer will make. Matching contributions are an immediate return on your investment: It's hard to match that anywhere else.
Realize Tax Benefits
Traditional 401(k) plans are tax-deferred, meaning that the money you put into your plan now is "pretax" or untaxed until you withdraw it when you retire. You can deduct your contributions on your tax return. Your money also grows tax-deferred until you withdraw it when you retire.
Consider a Roth 401(k)
Unlike a traditional 401(k), a Roth 401(k) is funded with after-tax dollars. You won't be able to deduct your contributions on your taxes, but your money will grow tax-free and you won't pay taxes on qualified distributions when you take the money out in retirement. However, not every retirement plan includes a Roth 401(k) option.
Know Your Vesting Period
Employer-based retirement plans often have a vesting period, which is the time an employee must work for an employer to own employer contributions. If you leave your job before you're fully vested, you may have to leave some of your money (typically all or some of your employer matching dollars) on the table. Before you submit your resignation, find out whether you are fully vested and what the implications are if you're not.
401(k) Income Limits Don't Have to Limit You
401(k) income limits are meant to apply to highly compensated employees. If you don't make more than $305,000 a year, you don't have to stress about how these limits will slow down your retirement savings. Contributing to a 401(k) can be a great way for you—and your employer—to save money on your taxes now and save toward your retirement down the line.
