The 401(k) contribution limits in 2023 are $22,500 for employees under age 50 and $30,000 for employees age 50 or older.
TABLE OF CONTENTS
Ways that employee compensation can be used to fund a 401(k) plan
Benefits of using employee compensation to fund a 401(k) plan
What is considered employee compensation for your 401(k) plan
What is excluded from compensation for 401(k) purposes
401(k) Highly Compensated Employee rules
Who Is a Highly Compensated Employee
What are the 401(k) contribution limits for highly compensated employees
Should a Highly Compensated Person still utilize 401(k)
What to do if you max out your 401(k) contributions
There are a few different ways that employee compensation can be used to fund a 401(k) plan.
- Payroll deductions. When an employee elects to participate in a 401(k) plan, their employer will deduct a certain amount of money from their paycheck each pay period and contribute it to their account.
- Lump-sum contributions. This is when an employee makes a one-time contribution to their account, rather than through payroll deductions. Lump-sum contributions can be made at any time, but they are most commonly made when an employee receives a bonus or other large sum of money.
- After-tax contributions. These contributions are not tax-deductible, but they grow tax-deferred in the account. After-tax contributions can be a good option for employees who are in a high tax bracket and want to save for retirement.
No matter how employee compensation is used to fund a 401(k) plan, it is a great way to save for retirement. A 401(k) plan offers a number of advantages, including tax-deductible contributions, tax-deferred growth, and employer-matching contributions.
Here are some of the benefits of using employee compensation to fund a 401(k) plan:
- Tax-deductible contributions: Contributions to a 401(k) plan are tax deductible, which means that you can deduct the amount of money you contribute from your taxable income. This can save you a significant amount of money on your taxes.
- Tax-deferred growth: The money in your 401(k) plan grows tax-deferred, which means that you do not have to pay taxes on the earnings until you withdraw the money from the account in retirement. This can also help you lower your tax burden now.
- Employer-matching contributions: Many employers offer matching contributions to their employees' 401(k) plans. This means that your employer will contribute a certain amount of money to your account for every dollar you contribute. This is essentially like getting a raise, and it's a great way to boost your retirement savings.
If you're an employee who is eligible to participate in a 401(k) plan, it makes smart financial sense to advantage of it. It is a great way to save for retirement and reach your financial goals.
What is considered employee compensation for your 401(k) plan?
The term "employee compensation" in a 401(k) plan refers to the amount of money that an employee earns from their job. This includes their salary, wages, commissions, bonuses, and other forms of taxable income.
Not all forms of compensation are considered employee compensation for 401(k) purposes. For example, the the value of your employer-provided healthcare plan or any travel expenses they might reimburse your for are not considered employee compensation.
What is excluded from compensation for 401(k) purposes
Here are some of the items that are excluded from compensation for 401(k) purposes:
- Reimbursements: If your employer reimburses you for expenses that you have incurred in the course of your employment, such as travel expenses or business meals, these reimbursements are not considered employee compensation for 401(k) purposes.
- Benefits: The value of your employer-provided benefits, such as health and life insurance, are not considered employee compensation for 401(k) purposes.
- Deferred compensation: If your employer offers a deferred compensation plan, such as a 401(k) plan, the amount of money that you defer into the plan is not considered employee compensation for 401(k) purposes.
- Moving expenses: If your employer reimburses you for moving expenses, the amount of the reimbursement is not considered employee compensation for 401(k) purposes.
- Severance pay: If you are terminated from your job and receive severance pay, the amount of the severance pay is not considered employee compensation for 401(k) purposes.
- Bonuses: Bonuses are considered employee compensation for 401(k) purposes, but only if they are actually paid to you. If your employer promises you a bonus but never pays it, the bonus is not considered employee compensation for 401(k) purposes.
- Stock options: The value of stock options that you have been granted by your employer is not considered employee compensation for 401(k) purposes until you actually exercise the options and purchase the stock.
Please note that these are just some of the items that are excluded from compensation for 401(k) purposes. The specific rules may vary depending on the type of 401(k) plan that you have.
401(k) Highly Compensated Employee rules
The 401(k) Highly Compensated Employee (HCE) rules are a set of regulations that apply to retirement plans sponsored by employers. The rules are designed to ensure that highly compensated employees (HCEs) do not receive an unfair advantage in the plan.
Who is a Highly Compensated Employee?
A "Highly Compensated Employee" (HCE) is a term often used in the context of retirement plan discrimination testing in the U.S., specifically regarding 401(k) plans and similar tax-advantaged retirement plans. The Internal Revenue Service (IRS) has guidelines to define who qualifies as an HCE, which can be based on either compensation or ownership.
The specific thresholds for an HCE can change from year to year due to inflation adjustments and other considerations.
To be considered an HCE, an employee must meet one of the following criteria:
- Own more than 5% of the employer's stock.
- Received more than $150,000 in compensation in the 2023 tax year and was in the company's top 20% in pay.
What are the 401(k) contribution limits for Highly Compensated Employees
Employers face a limit on the contribution match they offer their HCEs. In 2023, the limit was $330,000, according to the IRS. Here's an example of how the match would work:
Say you earn a salary of $400,000 and your employer matches 100% of your contributions up to 6%. If you were to contribute up to the limit of $22,500 to your 401(k), your employer could only match 6% of $330,000 not 6% of $400,000 because your salary exceeds the HCE limit.
There is also an absolute limit on how much an employer can contribute to an employee's 401(k) plan. In 2023, it's $66,000.
The 401(k) contribution limitation is designed to prevent HCEs from disproportionately benefiting from the plan. If you are an HCE, it is important to understand the contribution limits and restrictions that apply to you so that you can comply with them and avoid any penalties.
Should a Highly Compensated Person still utilize 401(k)?
Yes, a highly compensated person (HCE) should still utilize a 401(k) plan. Even though there are some restrictions on how much an HCE can contribute to a 401(k) plan, the benefits of doing so still outweigh the drawbacks.
Here are some of the benefits of using a 401(k) plan for HCEs:
- Tax-deductible contributions: Contributions to a 401(k) plan are tax-deductible, which means that you can deduct the amount of money you contribute from your taxable income. This can save you a significant amount of money on your taxes.
- Tax-deferred growth: The money in your 401(k) plan grows tax-deferred, which means that you do not have to pay taxes on the earnings until you withdraw the money from the account.
- Employer matching contributions: Many employers offer matching contributions to their employees' 401(k) plans. This means that your employer will contribute a certain amount of money to your account for every dollar you contribute. This is a great way to boost your retirement savings.
- Portability: 401(k) plans are portable, which means that you can take your money with you if you change jobs. This is a valuable benefit, as it allows you to keep your retirement savings even if you leave your employer.
What to do if you maxed out your 401(k) contributions
If you have maxed out your 401(k) contributions, there are still a number of ways to save for retirement. Here are a few ideas:
- Contribute to a Roth IRA: A Roth IRA is a type of individual retirement account that allows you to make contributions after-tax. The money in a Roth IRA grows tax-free, and you can withdraw the money tax-free in retirement.
- Make non-deductible contributions to a traditional IRA: If you are not eligible to deduct your contributions to a traditional IRA, you can still make non-deductible contributions. The money in a non-deductible traditional IRA grows tax-deferred, and you can withdraw the money tax-free in retirement.
- Invest in taxable accounts: You can also invest in taxable accounts, such as stocks, bonds, and mutual funds. However, keep in mind that the money in taxable accounts will be taxed on both the earnings and the withdrawals.
- Consider a 457 or 403(b) plan: If you are a government employee or you work for a nonprofit organization, you may be eligible to contribute to a 457 or 403(b) plan. These plans are similar to 401(k) plans, but they have different contribution limits and eligibility requirements.
- Talk to your employer about other retirement savings options: Your employer may offer other retirement savings options, such as a pension plan or a savings incentive match plan for employees (SIMPLE). These options may offer different benefits and drawbacks, so it is important to talk to your employer to learn more.
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