Q:

Why are 401(k)'s limited to 20 percent?

A:

Quick Answer

The 401(k) retirement plan’s 20 percent contribution limit was established by Congress to prevent high-earners from using the plan as a tax shelter. Without the limit, a wealthy business owner, athlete, executive or actor could place millions of dollars into the retirement plan and build wealth without paying income taxes.

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Full Answer

The contribution limit for the 401(k) plan protects the lower and middle class, making it so the tax burden for essential government services is shared by people of all income levels. Spotting excess contributions to the 401(k) plan is the responsibility of the employee and not the employer. Penalties for overpayment to a 401(k) plan include double taxation and having the retirement plan classified as non-qualified, meaning the plan does not receive any special tax benefits from the Internal Revenue Service. The exact dollar amount of the contribution limit increases by $500 each year to adjust for inflation.

The 20 percent contribution limit applies to multiple 401(k) plans that are held by the same person. People who hold more than one occupation or change jobs during a year need to track their 401(k) contributions to avoid overpayment. In addition to the 20 percent contribution limit, there are limits on catch-up contributions and money contributed as matching funds by the employer. As of 2015, $50,000 is the highest contribution amount that can be made to a 401(k) plan in a given year.

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