402(g) limit

The 402(g) limit, as defined by the Internal Revenue Service (IRS), refers to the maximum amount of elective deferrals that can be deducted from an individual's taxable income each year. The amount is subject to cost of living adjustments (“COLA”). For example, the 402(g) limit for the year 2023 was set at $22,500, and for the year 2024, it has been increased to $23,000. 

These limits ensure that employees can save a significant portion of their income in tax-advantaged retirement accounts, fostering long-term financial security.

Participants age 50 and over may be able to exceed the annual 402(g) limit if their plan offers catch up deferrals. Catch ups are deferrals made to a plan in excess of a 402(g) limit, plan document limit, or testing limit. The amount is subject to COLA. For example, the catch up limit for 2023 was $7,500, and stayed the same for 2024.

Applicability of the 402(g) limit

The 402(g) limit is an individual limit and is always based on the calendar year. Employees participating in multiple retirement plans subject to the 402(g) limit need to be particularly aware of the sum of their deferrals each calendar year. Understanding these limits is essential for employees who wish to maximize their retirement savings without facing adverse tax consequences.

How the 402(g) limit works

Elective deferrals are contributions made by employees to their retirement plans on a pre-tax or Roth basis. Each year, the IRS adjusts the 402(g) limit based on inflation and other economic factors to ensure that it remains relevant and beneficial for retirement savers. The IRS plays a critical role in updating the 402(g) limit, ensuring it aligns with current economic conditions and helps employees effectively plan for retirement.

Importance of staying within the 402(g) limit

Exceeding the 402(g) limit can result in significant tax implications, depending on whether you violated the limit in one plan or between multiple plans.

An individual who participates in multiple plans with unrelated employers must monitor their own deferrals to make sure they don’t exceed the 402(g) limit. If they exceed the limit for the year, they must request a distribution of the excess contributions from one of the plans by April 15 of the following year.  

The individual decides which plan they want to request the 402(g) distribution from. Contributions that exceed the 402(g) limit and are not timely distributed are subject to income tax in the year they are made and must be included in the employee's gross income if not timely refunded by April 15 of the following year. If corrective actions are not taken in a timely manner, the excess contribution is taxed twice: once during the year it is contributed via the participant’s Form 1040, and second when the funds are distributed from the participant’s account.

What is IRC Section 401(a)(30)?

IRC Section 401(a)(30) says that an employer's plan(s) cannot allow a participant to defer more than the 402(g) limit into its plan or any related employer’s plans. In other words, when administering the plan, the administrator needs to make sure to limit contributions to the 402(g) limit for the individual in that plan and any other plans of the employer (i.e., if the employer has more than one plan it sponsors or if there is a related controlled group with multiple plans). 

This limit is usually monitored by your third party administrator and any excesses are corrected when annual nondiscrimination testing is completed.

Violating IRC Section 401(a)(30) is a plan disqualification issue. If the plan allows an excess contribution, that excess must be distributed to the participant by 4/15 of the following year. The plan admin must monitor this limit and execute the distribution. If the excess is not distributed by 4/15, the participant will have a tax consequence AND the plan will have a disqualification issue. Under EPCRS, the IRS allows the plan to distribute the excess by 12/31 of the following year to self-correct the qualification issue. However, the participant will still have a negative tax consequence as described under 402(g) above.

How employees can maximize 402(g) contributions

To maximize retirement savings, employees should consider several strategies to maximize contributions up to the 402(g) limit. Firstly, contributing the maximum allowable amount to their retirement plans each year can significantly boost their retirement savings. Additionally, employees aged 50 and above can take advantage of catch-up contributions, which allow them to contribute an extra amount beyond the standard 402(g) limit. These catch-up contributions can help older employees accelerate their savings as they approach retirement.