Both employees and employers can make contributions to a workplace 401(k) plan. However, not all 401(k) plans permit the same contributions. Below is a summary of the different contributions a 401(k) plan can permit. Check out your Summary Plan Description (SPD) to understand which contributions are applicable to your plan.
These are contributions you make to your 401(k) account by payroll deduction.
The contributions you make to a 401(k) plan through payroll deductions are called elective deferrals. These contributions are generally made on a pretax basis, but a plan can also permit Roth deferrals, which are made on an after-tax basis. The key advantage for employees of Roth deferrals is that they can be withdrawn at retirement tax-free – including earnings when certain conditions are met.
Voluntary After-tax Contributions
Like Roth deferrals, these employee contributions are made on an after-tax basis. However, they are much rarer due to special testing rules that limit their applicability. Unlike Roth deferrals, their earnings are always taxed at withdrawal.
A “rollover” is a distribution from a prior employer’s retirement plan or personal IRA that you contribute to your current employer’s 401(k) plan. Today, most 401(k) plans accept rollover contributions. Rollovers are generally pre-tax contributions, but after-tax rollovers may also be allowed by your 401(k) plan.
These are contributions your employer can make to your 401(k) account. These contributions do not affect your paycheck.
A 401(k) plan can permit your employer to match a percentage of your elective deferrals. An example of a match formula is 50% of elective deferrals up to 6% of compensation. In other words, if you defer 6% or more of your compensation, you would receive a 3% of compensation match from your employer.
When a matching contribution is discretionary, its formula can be changed annually. This allows your employer to contribute more in years of high proﬁtability, and contribute less when business is not as good, without having to amend the plan’s contribution formula.
If the matching contribution is funded after the close of the year, a plan can require participants to work a certain number of hours during the plan year (up to 1,000 hours) and/or be employed on the last day of the year to receive a contribution.
Non-Elective (Profit Sharing) Contributions
A 401(k) plan can permit your employer to make “non-elective” contributions to you regardless of whether or not you make elective deferrals. When non-elective contributions are discretionary, their amount can be changed annually by the employer.
Employers have three major proﬁt sharing contribution options:
- Pro rata – allocates a uniform contribution percentage amongst participants
- Integrated – provides a greater allocation on compensation earned in excess of the “integration level” (usually the Social Security taxable wage base)
- New comparability – permits diﬀerent allocation rates based on employee
If the proﬁt sharing is funded after the close of the year, a plan can require participants to work a certain number of hours during the plan year (up to 1,000 hours) and/or be employed on the last day of the year to receive a contribution.
When a 401(k) plan makes safe harbor contributions to you, business owners (or other highly-compensated employees) can maximize their personal contributions without fear of contribution refunds due to failed IRS nondiscrimination testing. This benefit makes safe harbor 401(k) plans very popular with small businesses, who are the most likely to fail testing.
Employers have three safe harbor contribution options:
- 4 percent matching contribution
- 3.5 percent matching contribution (QACA safe harbor plans only)
- 3 percent non-elective contribution
All safe harbor contributions are non-discretionary contributions. They must be subject to 100 percent vesting (QACA contributions may be subject to a two-year cliff vesting schedule) and may not be subject to any allocation conditions.
The Internal Revenue Service (IRS) limits how much you and your employer can contribute to a 401(k) plan annually.
Elective Deferral Limit
Elective deferrals are limited by IRC section 402(g). For 2019, the 402(g) limit is $19,500, or 100% of your annual compensation, whichever is less. Additional catch-up contributions may be allowed by your plan if you are age 50 or older. For 2020, the catch-up limit is $6,500.
If your elective deferrals exceed the 402(g) limit, the excess amount must be returned to you and included in your gross income.
Total Contribution Limit
“Annual Additions” represent the sum of employee and employer contributions (including any reallocated forfeitures) made to your 401(k) account in a year. Annual Additions are limited by IRC section 415(c). For 2020, the 415(c) limit is the lesser of:
- 100% of your compensation
- $57,000 ($63,500 including catch-up contributions)
Your annual contributions can be limited further if your plan fails IRS nondiscrimination testing and you are a Highly Compensated Employee (HCE)
For 2020, you are defined as a HCE if you meet one of the following two criteria:
- You own more than 5% of your employer (directly or by family attribution) at any time during 2019 or 2020
- You received compensation in excess of $125,000 during 2019 (the “lookback” year). Your plan can limit this group to the top 20% of employees, ranked by compensation.