401(k) Contribution Limits: A Simple Explanation [2020]

How much money you can put in your retirement accounts changes each year, so make sure you know the 401(k) contribution limits for 2020.
Last updated Aug 6, 2020 | By Ben Walker
401(k) Contribution Limits

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Contributions to a 401(k) plan are an important step in planning and saving for your retirement. A standard 401(k) account is sponsored by your employer and provides a way for you to put a portion of your pre-taxed wages into retirement savings. However, there’s a limit on how much money you can contribute each year, called a contribution limit.

The 401(k) contribution limits can change from year to year, so it’s best to make a habit of checking on the allowed amounts each year as you work on your retirement plan and tax planning. This way you can avoid making a costly retirement mistake.

In this article, we’ll look at the 401(k) contribution limits for the tax year 2020. We’ll also explain where these limits come from and what types of limits may apply to your contributions. This is important information to know as you put together the best strategy for building your retirement nest egg.

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401(k) contribution limits for 2020

Your age Type of contribution limit 401(k) contribution limit
Under 50 Limit on individual contributions $19,500
50 or older Limit on individual contributions $26,000
Under 50 Overall limit on all individual and employer contributions combined $57,000
50 or older Overall limit on all individual and employer contributions combined $63,500

Understanding 401(k) contribution limits

Although the IRS allows tax advantages to 401(k) plans that benefit everyone, average or lower-income households stand to benefit the most. Any employee can contribute to a 401(k) account, but a low-wage worker may find it more useful than a high-earning individual due to the contribution limits. A lower-earning individual is less likely to hit the contribution limits and can, therefore, enjoy the full tax advantage. This gives people who are not high earners an opportunity to more easily grow their net worth.

Individual limits

The first couple rows in the table above show the limits everyone needs to know about when it comes to their 401(k) accounts in 2020:

  • If you’re under the age of 50, you can contribute up to $19,500 to your 401(k) plan
  • If you’re over the age of 50, you’re allowed a catch-up contribution of $6,500, which raises your total contribution limit to $26,000

These two limits ($19,500 and $26,000) are individual contribution limits. That means these are the amounts you can contribute individually to an employer-sponsored 401(k) plan. Any amount your employer contributes to the same plan wouldn’t count toward these totals.

You should also be aware there is a limit on the amount of your compensation that can be taken into account when it comes to employer matching. For 2020, that limit is $285,000. For example, if an employer matches contributions up to 3% of your annual salary and you make $300,000, only $285,000 of your salary would be eligible for the 3% match.

Overall limits

Your 401(k) plan also has an overall limit that puts a ceiling on both your individual contributions and any employer contributions. This limit comes into play if your 401(k) plan has employer matching or if there’s a possibility of profit sharing or non-elective employer contributions. The limit also comes into play if an individual has a solo 401(k) set up on the side for their small business or self-employment.

The overall limit for combined individual and employer contributions is $57,000 for under 50 and $63,500 if you’re 50 or older due to an allowance for catch-up contributions.

High-earner limits

The IRS has specific 401(k) contribution limits that apply for individuals it considers to be highly compensated employees and key employees. This is in an effort by the IRS to spread the benefit of tax breaks to all employees, regardless of income level.

To be considered a highly compensated employee, you must meet one of the following criteria:

  • Have more than 5% ownership in the company sponsoring your 401(k) plan
  • Make more than $130,000

To be considered a key employee, you must meet one of the following criteria:

  • Have more than 5% ownership in the company sponsoring your 401(k) plan
  • Have more than 1% ownership in the company sponsoring your 401(k) plan and make more than $150,000
  • Make more than $185,000

If you’re considered an HCE, you may not be able to contribute the full individual 401(k) limits. What you are allowed to contribute will depend on the total amount of contributions the non-HCE individuals in your company make. Each year a company will run a non-discrimination test to determine your limit. Any overages are returned to you as a refund and will be counted as taxable income for the year.

In addition, if it is determined that the total value of key employee plan accounts is more than 60% of the total value of 401(k) plan assets, the employer has to contribute up to 3% of compensation to all non-key employees. When a plan is imbalanced like this, it is called a top-heavy plan and the IRS requires plans to be non-top-heavy.

Bottom line

As you sit down to do your retirement planning, remember to regularly check on the different contributions limits. For instance, contributions to traditional IRAs (Individual Retirement Accounts) can also help reduce your tax burden but you can’t contribute as much to them as you can a 401(k). And Roth IRAs have income limits associated with the contributions you’re allowed to make.

Contributions limits alone do not make one account better than another, though. Overall, it’s considered a best practice to fund multiple types of accounts. This creates a safe and diversified way to save the most money for retirement and to allow for the kinds of distributions you’ll need to live off when your income-earning years come to an end.

The important thing is that you’re taking both retirement planning and tax planning into account and saving enough to meet your financial goals for your future. If you’d like guidance in putting your plan together, then you may want to speak with a financial advisor.

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