401(k) contribution limits determine how much an employee can contribute to a retirement plan, but often limit benefits such as tax deferrals and employer matches. Employers set limits based on a percentage of salary, while the US government imposes a dollar maximum to prevent deferred tax money. Individuals can still contribute beyond limits, but lose employer matches and tax deferrals.
401(k) contribution limits are limits set each year, some by an employer and some by the government, that largely determine how much an employee can contribute to a retirement plan. However, it should be noted that 401k contribution limits often do not limit the amount that can be contributed, but rather limit some of the benefits that a 401k provides. These benefits include tax deferrals and employee contributions.
Employers will often match a contribution to a 401(k) plan. This match could be dollar-for-dollar or less, depending on the type of 401(k) plan you have. However, there are some types of 401(k) plans that require a dollar-for-dollar match.
If there is a match with the employer, the employer will most likely propose 401(k) contribution limits, simply so it doesn’t become too cumbersome a program to fund. These limits may be based on a percentage of the employee’s salary. Often, there is a wide range of percentages, depending on individual employer preference. Typically, these 401(k) contribution limits can range from 4 to 12 percent of the employee’s salary.
In addition, the United States federal government imposes a dollar maximum each year. This changes annually and is usually announced at least a year in advance. The 401k contribution limits imposed by the US government are somewhat controversial. However, the most cited reason offered for the limits is because the United States does not want to defer too much tax money for the future.
All 401(k) contributions, up to a certain dollar amount, are tax-deferred, meaning taxes won’t be paid until the individual collects the money. Therefore, some income taxes that would otherwise be paid may be delayed. If too much money goes into 401(k) plans, it could cause a cash shortage in the nation’s general fund budget. Imposing 401(k) contribution limits helps keep tax deferrals within certain predictable parameters.
It should also be noted that those interested in contributing to a retirement plan need not be subject to 401(k) contribution limits. Often, people do not want to give more than the limits imposed by employers and the US government because the perceived benefit is not that great. This is because the employer match ceases and the tax deferral stops. However, for those who don’t mind paying taxes on money that goes into a retirement plan, still contributing to a 401(k) is an option.
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