It sounds like a win-win situation on the surface. You can contribute to a 401(k), investing in your retirement, and the Internal Revenue Service lets you do it tax-free – at least until you begin to withdraw the money and its earnings. You invest with pre-tax dollars, reducing your taxable income so you pay taxes on fewer earnings.
Now take a breath and step back to reality. Yes, you can do all this, but the IRS isn’t known for unlimited generosity.
You can only contribute tax-free to a 401(k) up to certain limits per year.
Each year, the IRS sets limits for maximum contributions you can make to your 401(k) plan. People can contribute up to $18,500 in 2018 as an elective salary deferral to a 401(k) plan. And if you’re age 50 or older, you can make an additional “catch-up” contribution of $6,000.
Contribution limits have historically been set at the following thresholds:
|401(k) Contribution Limits by Year|
|Year||Elective Salary Deferral Limit||Catch-up contributions if age 50 or older||Total Possible Employee Contribution Limit||Source|
The limit applies to all 401(k) accounts you might have in the current year. If you work at two or more jobs or switch jobs in the middle of the year, you may have to track your 401(k) contributions to make sure they don’t exceed the maximum allowed.
If you can contribute the maximum, it’s probably easiest to break the annual limit down into equal installments per pay period. You’ll be saving the same amount each pay period that way and will be dollar-cost-averaging into your retirement investments.
Elective salary deferrals can be placed into either a tax-deferred traditional 401(k) or into a post-tax Roth 401(k) account. You can even make a combination of contributions to both traditional and Roth accounts as long as the total of all salary deferrals is equal to or less than the annual maximum.
Your Employer’s Contributions
Matching contributions from your employer are limited to 25 percent of your salary. If you’re self-employed and funding your own 401(k), the matching contribution is limited to 20 percent of your net self-employment income. Matched funds are always contributed to the tax-deferred portion of the 401(k) plan and never to the after-tax Roth portion of a 401(k) plan.