A 401(k) is a feature of a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts.
Generally, you aggregate all elective deferrals you made to all plans in which you participate to determine if you have exceeded these limits. If a plan participant’s elective deferrals are more than the annual limit, find out how you can correct this plan mistake.
Elective salary deferrals are excluded from the employee’s taxable income (except for designated Roth deferrals).
Employers can contribute to employees’ accounts.
You are required to pay FICA tax on all contributions you make to your 401(k) plan. However, if your employer makes contributions to your 401(k), these funds are not subject to FICA tax.
Distributions, including earnings, are includible in taxable income at retirement (except for qualified distributions of designated Roth accounts).
Because 401(k)s are tax-advantaged, they have a maximum annual contribution limit set by the IRS. That limit sometimes gets adjusted from year to year.
Note that the amounts above are the “elective deferral limit” — the amount you, as an employee, are allowed to contribute out of your salary each year. Employer matching dollars do not count toward that limit.
There’s a reason employees are encouraged to take advantage of employer-matched 401(k) plans: free money.
Employers who match employees’ contributions often do so between 3% and 5% of your salary. So if you make $50,000 and contribute 5% of your salary ($2,500) and your employer matches that 5%, you’ll add $5,000 to your balance each year.
The 401(k) also has an annual total contribution limit, which caps the combined amount you and your employer can contribute. In 2020, your total 401(k) contributions — from yourself and your employer — cannot exceed $57,000 or 100% of your compensation, whichever is less. That limit rose from $56,000 in 2019.