401k Contribution Guidelines and Limitations

Federally mandated limitations govern how much an employee can contribute to his or her 401k plan each year, and how much the employer can likewise contribute to the company's plan. The following information and examples are provided by the IRS:

Limitation on Elective Deferrals

There is a limit on the amount of elective deferrals that you can contribute to your traditional or safe harbor 401(k) plan. The limit is increased annually, subject to cost-of-living increases. Generally, all elective deferrals that you make to all plans in which you participate must be considered to determine if the dollar limits are exceeded. Limits on the amount of elective deferrals that you can contribute to a SIMPLE 401(k) plan are different from those in a traditional or safe harbor 401(k).

Although general rules for 401(k) plans provide for the dollar limits as described above, that does not mean that you are entitled to defer that entire amount. Other limitations may come into play that would limit your elective deferrals to a lesser amount. For example, your plan document may provide a lower limit or the plan may need to further limit your elective deferrals in order to meet nondiscrimination requirements.

Catch-Up Contributions

A plan may permit participants who are age 50 or over at the end of the calendar year to make additional elective deferral contributions. These additional contributions (commonly referred to as “catch-up” contributions) are not subject to the general limits that apply to 401(k) plans. An employer is not required to provide for catch-up contributions in any of its plans. However, if your plan does allow catch-up contributions, it must allow all eligible participants to make the same election with respect to catch-up contributions.

If you participate in a traditional or safe harbor 401(k) plan and you are age 50 or older, the elective deferral limit increases annually, subject to cost-of-living increases. If you participate in a SIMPLE 401(k) plan and you are age 50 or older the elective deferral limit increases annually, subject to cost-of-living increases.

The catch-up contribution you can make for a year cannot exceed the lesser of the following amounts: The catch-up contribution limit, above, or the excess of your compensation over the elective deferrals that are not catch-up contributions.

If you participate in plans of different employers, you can treat amounts as catch-up contributions regardless of whether the individual plans permit those contributions. In this case, it is up to you to monitor your deferrals to make sure that they do not exceed the applicable limits.

Example: If Joe Saver, who’s over 50, has only one employer and participates in that employer’s 401(k) plan, the plan would have to permit catch-up contributions before he could defer the maximum of $20,500 for 2008 (the $15,500 regular limit for (example) 2008 plus the $5,000 catch-up limit for 2008). If the plan didn’t permit catch-up contributions, the most Joe could defer would be $15,500. However, if Joe participates in two 401(k) plans, each maintained by an unrelated employer, he can defer a total of $20,500 even if neither plan has catch-up provisions. Of course, Joe couldn’t defer more than $15,500 under either plan and he would be responsible for monitoring his own contributions.

The rules relating to catch-up contributions are complex and your limits may differ according to provisions in your specific plan. You should contact your plan administrator to find out whether your plan allows catch-up contributions and how the catch-up rules apply to you.

Treatment of Excess Deferrals

If the total of your elective deferrals is more than the limit, you can have the difference (called an excess deferral) returned to you from any of the plans that permit these distributions. You must notify the plan by April 15 of the following year of the amount to be paid from the plan. The plan must then pay you that amount plus allocable earnings by April 15 of the year following the year in which the excess occurred.

Excess Withdrawn by April 15

If you withdraw the excess deferral for (example) 2007 by April 15, 2008, it is includable in your gross income for 2007, but not for 2008. However, any income earned on the excess deferral taken out is taxable in the tax year in which it is taken out. The distribution is not subject to the additional 10% tax on early distributions.

Excess Not Withdrawn by April 15

If you do not take out the excess deferral by (example) April 15, 2008, the excess, though taxable in 2007, is not included in your cost basis in figuring the taxable amount of any eventual distributions from the plan. In effect, an excess deferral left in the plan is taxed twice, once when contributed and again when distributed. Also, if the entire deferral is allowed to stay in the plan, the plan may not be a qualified plan.

Reporting Corrective Distributions on Form 1099-R

Corrective distributions of excess deferrals (including any earnings) are reported to you by the plan on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.

Additional Limits

There are other limits that restrict contributions made on your behalf. In addition to the limit on elective deferrals, annual contributions to all of your accounts - this includes elective deferrals, employee contributions, employer matching and discretionary contributions and allocations of forfeitures to your accounts - may not exceed the lesser of 100% of your compensation or (example) $46,000 (for 2008, $49,000 for 2009). In addition, the amount of your compensation that can be taken into account when determining employer and employee contributions is limited. In 2008, the compensation limitation was $230,000; for 2009, the limit was $245,000. This limit also increases annually, subject to cost-of-living.