If you’re planning for your retirement and have a 401(k) retirement savings plan, it’s important to understand the contribution limits for 2023. In this guide, we’ll break down the limits and provide you with important information to help you maximize your contributions.

Understanding 401(k) Contribution Limits for 2023

The Internal Revenue Service (IRS) sets annual limits on the amount of personal contributions allowed in a 401(k) plan. These limits are adjusted for inflation and cost of living increases each year. For 2023, the personal contribution limit is $22,500.

However, if you are age 50 or older, you have the opportunity to make additional catch-up contributions. This means you can contribute an extra $6,500, bringing your total personal contribution limit to $29,000.

It’s important to note that these contribution limits also apply to other retirement plans such as 403(b) plans, most 457 plans, and the federal government’s Thrift Savings Plan.

The Complexity of 401(k) Plans

While the contribution limits may seem straightforward, 401(k) plans can have additional complexities. Let’s delve into the finer points.

Empower Financial Advisor

Before we dive into the details, let’s take a moment to introduce Empower Financial Advisor. This financial advisory service offers managed accounts with annual fees based on your assets under management (AUM). With Empower, you can optimize your retirement savings strategy and make the most of your 401(k) contributions.

Maximum Total Contribution Limits for 2023

In addition to personal contributions, there are maximum total contribution limits in place. These limits include employer contributions, Roth 401(k) contributions, and personal non-tax-deductible contributions (if allowed by your plan).

For employees who are under 50 years old, the maximum total contribution limit for 2023 is $58,000. This includes the $22,500 personal contribution limit.

If you are 50 or older, the maximum total contribution limit increases to $64,500. This includes the $29,000 personal contribution limit.

Keep in mind that these limits apply to all 401(k), 403(b), and most 457 plans.

The Importance of 401(k) Compensation Limits for 2023

To ensure fair participation in 401(k) plans, the IRS also establishes compensation limits. These limits determine the maximum amount of compensation that employers can consider when making contributions to their employees’ 401(k) plans.

For 2023, the employer can only consider up to $290,000 in compensation for calculating contributions to your 401(k) plan.

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Highly Compensated Employees (HCEs) and Key Employees

Highly compensated employees (HCEs) and key employees have different rules and regulations when it comes to contribution limits.

If you own 5% or more of the company that employs you or receive compensation of $130,000 or more in 2023, you are classified as an HCE. As an HCE, you are subject to non-discrimination tests to ensure that you do not receive unfair tax-saving advantages over non-HCEs.

Key employees, on the other hand, are classified based on ownership and/or salary. If you are a 5% owner, a 1% owner who receives over $130,000 in compensation, or an officer who receives compensation over $185,000, you are considered a key employee and subject to non-discrimination tests.

Contributing to Multiple 401(k) Plans

If you have multiple 401(k) plans at different employers, the contribution limits still apply. Your personal contribution limit of $22,500 or $29,000 (if you’re 50 or older) applies to all your 401(k) accounts. In other words, the combined contributions to all your 401(k) plans cannot exceed the personal contribution limit.

Navigating Non-Discrimination Tests

Non-discrimination tests are conducted to ensure that HCEs and key employees do not receive more benefits from a 401(k) plan than non-HCEs. There are three main tests that companies must perform yearly:

  1. Actual Deferral Percentage (ADP) Test: This test compares the deferral percentage of HCEs to non-HCEs. If the difference is more than 2%, the plan fails and must be corrected.

  2. Actual Contribution Percentage (ACP) Test: Similar to the ADP test, the ACP test compares the contribution percentage of HCEs to non-HCEs. If the difference is more than 2%, the plan fails the test and must be corrected.

  3. Top-Heavy Test: This test determines whether a plan is top-heavy, meaning the majority of the plan’s assets are held by key employees. If this is the case, the employer must make additional contributions to benefit non-key employees.

Failure to pass these tests may require corrections, such as refunding excess contributions to HCEs or making additional contributions to non-key employees.

Contribution Limits in Excess of Annual Limits

If your personal contributions, including Roth contributions, exceed the annual limit, corrective action must be taken. Your employer will need to return the excess contributions, along with any earnings, to you by April 15, 2024. These excess contributions will be added to your gross income for the tax year and will be subject to taxation.

It’s important to note that excess Roth contributions are not subject to taxation, but any earnings on those contributions are.

After-Tax 401(k) Contribution Limits

If your 401(k) plan allows after-tax (non-Roth) contributions, they are not subject to the personal contribution limit mentioned earlier. This means you can make additional contributions to supplement your employer’s contribution. The maximum all-sources contribution limit for employees under 50 is $58,000, and for employees 50 and older, it is $64,500.

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How Much Should You Contribute to Your 401(k)?

While the contribution limits provide guidance, determining how much to contribute depends on various factors. It’s generally recommended to contribute between 10% and 15% of your income each year. However, take advantage of your employer match if available, and consider leveraging other retirement savings options such as IRAs and taxable investment accounts.

Maximizing Your 401(k) Contributions

To make the most of your 401(k) contributions, consider the following strategies:

  1. Increase Your Savings Rate: Set your own savings rate, higher than the default rate, to maximize your contributions.

  2. Take Advantage of Employer Matching: Ensure you contribute enough to receive the full employer match, as it is essentially free money.

  3. Understand Vesting: Be aware of any requirements or restrictions on receiving the employer match, such as the need to stay with the company for a certain period of time.

  4. Consider the Saver’s Tax Credit: Check if you qualify for the Saver’s Tax Credit, which can provide additional tax benefits for contributing to retirement plans.

  5. Explore Roth 401(k) and After-Tax Contributions: If available, consider making contributions to a designated Roth 401(k) or after-tax contributions to maximize your savings.

  6. Keep Track of Your 401(k) Accounts: To ensure you don’t lose track of your 401(k) accounts, reach out to former employers and utilize resources like Beagle to locate any lost accounts.

Other Retirement Savings Options

In addition to your 401(k), there are other avenues to consider when saving for retirement. These include:

  • Financial Advisor: Seek guidance from a financial advisor, such as Empower Financial Advisor, to optimize your retirement planning.

  • Individual Retirement Account (IRA): Explore traditional and Roth IRAs, which offer additional tax advantages and contribution limits on top of your 401(k).

  • Health Savings Account (HSA): Utilize an HSA to save for healthcare expenses in retirement, with contributions that are tax-deductible and withdrawals that are tax-free for qualified healthcare expenses.

  • Taxable Investment Account: Consider investing post-tax funds in a brokerage account to expand your investment options beyond tax-advantaged accounts.

  • Tax-Deferred Annuities: Explore insurance company annuities, which offer tax deferral and various investment options for steady retirement income or capital gains.

  • Real Estate: Consider real estate investments, such as real estate investment trusts (REITs) or rental properties, to diversify your retirement portfolio.

Conclusion

Contributing to a 401(k) plan is an excellent way to save for retirement. By understanding the contribution limits and exploring additional retirement savings options, you can take control of your financial future. Remember, it’s never too early or too late to start saving for retirement.

For more in-depth guidance on retirement planning, be sure to check out insightful resources like Playbook. Playbook offers strategic tax planning and financial planning services to help you optimize your retirement savings.

Remember, your retirement is in your hands. Start planning today to secure a comfortable future.

[ADP]: Actual Deferral Percentage
[ACP]: Actual Contribution Percentage
[HCE]: Highly Compensated Employee
[AGI]: Adjusted Gross Income

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