401(k) contribution limits
The 401(k) contribution limit for individuals has been increased to $22,500 for 2023. For those who are age 50 or over at any time during the year, the catch-up contribution limit is $7,500. So, those aged 50 or over can contribute a total of $30,000 to their 401(k) during 2023.
The 2023 contribution limits are the same for those of you who might be covered by a 403(b). Certain nonprofit organizations, hospital groups, public education organizations, and others offer this type of employer-sponsored plan.
The limits for most 457 plans are the same. For those 50 and over, there is a special catch-up limit to allow for faster saving. If you are within three years of retirement, this special catch-up limit is twice the normal contribution rate or $45,000 for 2023. Those using this option cannot also take advantage of the regular $7,500 catch-up. These types of plans are common for many local and state government employers as well as some nonprofits.
For all three plans, the sum of your contributions cannot exceed 100% of your compensation.
Employer matching
In addition to your own contribution via salary deferral, your employer might offer matching contributions to your 401(k) account. These are not mandatory and are determined by each employer.
A common type of match is a percentage tied to the amount you contribute. For example, the employer might offer a match of 50% on the first 6% of your salary that you contribute to the plan.
Safe harbor plans offer either a flat contribution to each participant's account whether or not they contribute or one of two matching formulas. Employers use safe harbor plans to ensure that the highly compensated employees can contribute the maximum amount to the plan regardless of the level of contributions made by the rest of the company's employees. The company is required to send the employees an annual safe harbor notification to inform them that this option is in effect for the upcoming year.
The employer's contribution under a safe harbor plan is vested immediately. So, this money is entirely yours to take with you if you leave the company. With ordinary matching contributions, there is usually a time frame during which you become vested in the employer contributions to your account. A common vesting formula is five years. Your claim to these contributions increases by 20% annually until you reach 100% at the end of year five.
Another type of employer contribution to a 401(k) plan is a profit-sharing contribution. This is an annual discretionary contribution. Your employer is not obligated to make this contribution to your account each year. The limit on profit-sharing contributions is 25% of an individual's salary.
Solo 401(k)
A solo or individual 401(k) plan is geared toward those who are self-employed. This plan is open to business owners, spouses, and business partners. This plan is not open to employees at large.
The contribution limits for employee contributions are the same as discussed above, $22,500 or $30,000.
A solo 401(k) plan is also eligible for employer profit-sharing contributions. These are based on a limit of 25% of your compensation from your business. This can be in the form of the salary you pay yourself if you are a corporation, LLC, or similar entity.
For those who are sole proprietors, the limits would be based on the net income from the business. The actual percentage will likely be lower than 25%. This is because of the way the calculation flows through Schedule C.
The maximum employer or profit-sharing contribution limits combined with employee contributions are $66,000 or $73,500 for those who are 50 or over.
If you are self-employed, you should discuss the limits and potential tax benefits with your financial or tax advisor.
Roth 401(k) limits
Like a Roth IRA, a Roth 401(k) is funded with after-tax money. That means you won't have to pay taxes on qualified distributions in the future (although you will still have to report them to the IRS), making the Roth a good choice for individuals who think they will be in a higher tax bracket come retirement time.
The contribution limits for a Roth 401(k), if your plan offers this option, are the same as the traditional 401(k) limits already mentioned at $22,500 and $30,000. This can be helpful for those who earn too much to contribute to a Roth IRA and/or who want to maximize their Roth contributions overall.
Any employer matching or profit-sharing contributions will be made to a traditional (pre-tax) 401(k) account on your behalf. This is a rule and not the employer's choice.
Summary
Your 401(k) is likely your biggest retirement savings vehicle. Studies have shown that the biggest determinant of the size of your retirement nest egg is the amount contributed. Be sure you are maximizing your 2023 contributions to the limits or to the greatest extent that you can afford.
