LAST REVIEWED Nov 07 2022 13 MIN READ
Each year, the IRS places limits on the maximum amount participants can contribute to their 401(k) plans
Participants can contribute up to $22,500 to their 401(k) plans in 2023 (up from $20,500 in 2022)
Participants aged 50 years or older can contribute an additional $7,500 in catch-up in 2023
A 401(k) is a common type of retirement account in which you contribute savings that come out of your paycheck before you pay income tax. Most commonly, employers sponsor an employee’s 401(k). However, sole proprietors, independent professionals, and other small business owners with no employees except for a spouse may qualify for a self-employed (solo) 401(k).
Each year, participants can save up to the max 401(k) contribution established by the Internal Revenue Service (IRS). The IRS increased contribution limits in 2023 for 401(k) plans and more. Here’s what you need to know.
401(k) contribution limits
Contribution limits: $22,500 in 2023 (up from $20,500 in 2022)
401(k) catch-up contributions limits
Employees with a 401(k), 403(b), or 457 account and 50 years or older can contribute additional funds annually to their plans. Known as catch-up contributions, these also have annual contribution limits, which generally receive an annual cost-of-living increase.
Catch-up contribution limits: $7,500 in 2023 (up from $6,500 in 2022)
These additional contributions are meant to help individuals nearing retirement age increase the total value of their retirement account. Taking maximum salary deferral and catch-up contributions into account, an individual can contribute a total amount of $30,000 to a 401(k) and 403(b) plan in 2023.
Employer contribution limits
Many employers match a percentage of their workers’ 401(k) contributions as a valuable employee benefit. Most employers match a portion of their employee’s contributions. In fact, 75% of all Human Interest plans offer an employer match, according to Human Interest data from January 2022.
There are several employer match formulas, but most 401(k) match programs usually use a percentage of an employee’s own contributions or a percentage of the employee’s salary to calculate the total possible match. Of the Human Interest plans that offer a match, 42% offer $1.00 per dollar on the first 4% to their employees.
Does my employer’s 401(k) match count toward my maximum contribution?
To put it simply, the answer is “no.” An employer matching contribution does not count towards your maximum contribution of $22,500. However, the IRS does limit total contribution to a 401(k) from both the employer and the employee—which means total contributions can't exceed either:
100% of an employee's salary, or
The limit for defined contributions ($66,000 in 2023).
The limit for defined contribution plans in 2023 under section 415(c)(1)(A) is $66,000 (up from $61,000 in 2021). Workers 50 years and older are still eligible for a $7,500 catch-up contribution and can have a maximum of $73,500 in employer and employee contributions including catch-up contributions in 2023.
Solo 401(k) limits
If you’re self-employed, you may fund your own plan through financial institutions that offer solo 401(k) accounts. Called a one-participant 401(k) by the IRS, these plans have the same rules and requirements as a traditional 401(k) plan, and cover a business owner with no employees (other than a spouse working for the business).
The main difference in one-participant plans is that, as a business owner, you wear two hats— employee and employer—meaning contributions can be made in both capacities:
Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual—see below) within annual contribution rates:
$22,500 in 2022, or $30,000 in 2022 if age 50 or over; plus
Employer contributions up to:
25% of compensation as defined by the plan
How solo 401(k) contribution limits work
If you’re a self-employed individual, you must calculate the maximum amount of elective deferrals and nonelective contributions you can make. When figuring out your contribution, your compensation is your “earned income,” or, your net earnings from self-employment after deducting both:
Deductible employer contributions for yourself
One-half of your self-employment tax
Keep in mind that self-employed individuals must often pay the employer costs associated with 401(k) plans, typically including a one-time start-up fee, as well as a monthly account maintenance fee. You might also pay fees on the specific investments you purchase with your 401(k) funds (although some plans have these incorporated into their fee structures).
For more information, refer to the IRS table and worksheets found in Publication 560, Retirement Plans for Small Business.
Traditional (pretax) vs. Roth 401(k) deferrals
Most 401(k) plans sponsored by an employer offer both traditional (pretax) and Roth deferral options. These accounts differ in how the account owner pays taxes—although contribution limits are the same.
In a pretax 401(k) account, deferral contributions are made to the plan before taxes are withheld and you are subject to income tax when funds are withdrawn.
In a Roth account, deferral contributions are made to the plan after taxes are withheld. Your Roth contributions are always tax-free and earnings may be tax-free if you meet certain requirements.
In other words, for Roth contributions, the money for your retirement comes out of your paycheck after you pay income taxes on those funds, not before. However, you enjoy a deferred tax benefit because you can withdraw the money in retirement without paying income tax (if certain requirements are met).
Think about when your tax burden will likely peak to determine whether a traditional or Roth 401(k) account is most appropriate for your needs. If you have not been working for very long, you will probably be in a higher tax bracket when you retire and may want to consider investing in a Roth 401(k) account.
If you are near the apex of your career, a pretax401(k) account may be a better choice because you will likely land in a lower tax bracket after you retire. You may also want to opt for a pretax 401(k) if you like the idea of getting your tax payments out of the way long before you retire. Want the flexibility of tax diversification? You can even divide your maximum 401(k) contributions between traditional and Roth accounts each year to help optimize your tax advantages.
Other IRS retirement account changes for 2023
In addition to contribution increases to 457, 403(b), and 401(k) plans, the IRS has additional 2022 updates:
SIMPLE retirement plan contribution limits increased to $15,500 in 2023 (up from $14,500 in 2022).
Traditional and Roth IRA contribution limits increased to $6,500 in 2023 (up from $6,000 in 2022); traditional and Roth IRA catch-up contribution limits remain at $1,000.
Income ranges for determining eligibility to make deductible contributions to traditional IRAs, to contribute to Roth IRAs, and to claim the Saver's Credit all were raised for 2023.
Why does the IRS impose contribution limits?
Contributions to 401(k) plans made using pretax dollars provide significant tax benefits. This means you don’t have to pay federal income tax for contributions up to the $22,500 limit (or $30,000 if you’re 50 or older), which lowers your taxable income. And because earnings in a pretax 401(k) account are on a tax-deferred basis, earnings in your account are not subject to tax until you withdraw your funds.
Because of the substantial tax benefits offered by 401(k) retirement plans, the IRS works to ensure that plans do not unfairly benefit key employees and highly compensated employees. To ensure a 401(k) plan is structured fairly and not favoring specific employees, all 401(k) plans must pass a set of annual compliance tests.
Benefits of contributing to your 401(k) plan
401(k) account contributions provide a double tax advantage for taxpayers. Individuals are able to direct pre-tax funds from their paycheck into their 401(k), reducing the amount of their income subject to income taxes for the year. In addition, any earnings from 401(k) account contributions are also tax-deferred.
Individuals will need to pay income taxes on funds taken out of 401(k) accounts when withdrawn, typically during retirement. However, many find their income is lower during retirement than it was while working, placing them in a lower tax bracket.
How do the immediate tax savings work with my 401(k) account?
Let’s look at a quick example to illustrate the benefits of contributing to a 401(k) plan. Jenae earns $100,000 per year and doesn’t contribute to a retirement plan. She’s 27 years old, single, has no dependents, and will be taking the standard deduction of $13,850 for 2023*.
|Adjusted gross income||$100,000|
|Federal tax due (estimate)||$14,261|
Now, imagine that Jenae contributes the maximum $22,500 to her 401(k) account in 2023:
|Adjusted gross income||$100,000|
|Federal tax due (estimate)||$9,311|
The immediate tax benefit of contributing the maximum amount allowed by law to a 401(k) in 2023 is an estimated 50.76% in tax savings—or $4,950 for Jenae.
401(k) plans designed for small business employees
Getting started with investing may seem intimidating, but it doesn’t have to be. Your 401(k) is a tool to help you save for retirement—and this guide is designed to help you think about long-term investments.
Human Interest offers flexible, customized plans designed to help employees invest for retirement. If you want to set up or switch to a 401(k) plan that’s focused on the needs of small and medium-sized businesses, let your company know about Human Interest.
The Human Interest Team
We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment education, and integration with leading payroll providers.