The 401(k) contribution limits are limits set each year, some by an employer and some by the government, that largely determine how much an employee may want to contribute into a retirement plan. However, it should be noted 401k contribution limits often do not limit the amount that can be contributed, but rather limit some of the benefits 401ks provide. These benefits include tax deferments and employee contributions.
Employers will often match a contribution to a 401(k) plan. This match could be dollar for dollar or less than that, depending on the type of 401(k) plan owned. However, there are some types of 401(k) plans that do require a dollar-for-dollar match.
If there is an employer match, then it is very likely that employer will propose 401(k) contribution limits, simply so that it does not become too cumbersome of a program to fund. These limits may be based on a percentage of the employee's salary. Often, there is a wide range of percentages, based on the individual employer's preference. Usually these 401(k) contribution limits can range anywhere from 4 percent to 12 percent of the employee's salary.
Furthermore, the U.S. federal government imposes a dollar maximum each year. This changes annually and is usually announced at least a year in advance. The 401k contribution limits imposed be the U.S. government is somewhat controversial. However, the most cited reason offered for the limits is because the United States does not want to defer too much tax money to the future.
All 401(k) contributions, up to a certain dollar amount, are tax deferred, meaning the taxes will not be paid until the money is collected by the individual. Therefore, some income tax otherwise to be paid can be delayed. If too much money goes into 401(k) plans, this could cause a cash deficiency in the country's general fund budget. Imposing 401(k) contribution limits helps keep the tax deferment within certain predictable parameters.
It should also be noted that those interested in contributing to a retirement plan do not need to be held to the 401(k) contribution limits. Often, people do not want to give more than the limits imposed by employers and the U.S. government because the perceived benefit is not as great. This is because the employer match ceases and the tax deferment stops. However, for those who do not mind paying taxes on money going into a retirement plan, still contributing to the 401(k) is an option.
