What Is an Elective-Deferral Contribution?
An elective-deferral contribution is an employee-directed contribution made directly from their salary into an employer-sponsored retirement plan, such as a 401(k) or 403(b) plan. Employees must provide authorization to initiate this transaction.
Elective deferrals can be made pre-tax. The IRS sets limits on how much an employee can defer or contribute to a qualified retirement plan. An elective-deferral contribution is also called a salary-deferral or salary-reduction contribution.
Key Takeaways
- An elective-deferral contribution is a fraction of an employee’s salary that’s withheld and deposited into a retirement plan like a 401(k).
- Elective deferrals can be pre-tax or after-tax, depending on the employer’s offerings.
- The IRS defines the maximum contribution to a qualified retirement plan.
- Individuals under 50 can contribute up to $22,500 in 2023 and $23,000 in 2024.
- Individuals aged 50 and above can make catch-up contributions, raising their limits to $30,000 in 2023 and $30,500 in 2024.
How Elective-Deferral Contributions Work
Elective-deferral contributions to traditional 401(k) plans are made on a pre-tax basis, thus lowering an employee’s taxable income. For instance, a worker earning $40,000 annually who defers $100 per month to their 401(k) will have deferrals totaling $1,200 for the year. This action reduces their taxable income to $38,800 from $40,000 for that year.
As upfront tax deductions apply, distributions will be taxed according to the retiree’s income tax rate at withdrawal. Restrictions on when and under what circumstances one can make withdrawals exist, and penalties such as a 10% tax may apply for those withdrawing before age 59½. State and local taxes might also be levied on early withdrawals.
Employers may also offer Roth 401(k) plans where contributions occur on an after-tax basis. Taxed at the time of deposit, these funds can later be withdrawn tax-free if the employee is over 59½. Unlike Roth IRAs, Roth 401(k)s are not subject to Required Minimum Distributions (RMDs) during the owner’s lifetime.
Elective-Deferral Contribution Limits
The IRS defines strict limits on contributions to an employee’s qualified retirement plan.
Employee Contribution Limit
In 2023, employees under 50 can contribute up to $22,500 to their 401(k) accounts, rising to $23,000 in 2024. Those aged 50 and over can additionally contribute $7,500, totaling $30,000 for 2023 and $30,500 for 2024. These rules equally apply to Roth 401(k)s.
These limits also encompass multiple 401(k) accounts; thus, a person can contribute up to the combined limit if participating in both traditional and Roth 401(k) plans.
Employee and Employer Total Contribution Limit
These limits only apply to employee contributions. Employer matching, non-elective employee contributions, and allocable forfeitures follow additional IRS rules. Combined contributions from all sources (employee and employer) cannot surpass:
- 100% of the employee’s compensation
- $66,000 (2023) or $73,500 with catch-up contributions
- $69,000 (2024) or $76,500 with catch-up contributions
What Is the IRS Limit for Elective Deferrals?
The IRS-limited contribution for elective deferrals is $22,500 in 2023 and $23,000 in 2024. Employees aged 50 and above can add $7,500, bringing their totals to $30,000 in 2023 and $30,500 in 2024. Matching and additional contributions by the employer must adhere to the lower of 100% of the salary or the specified yearly caps.
Are Elective Deferrals Tax Deductible?
While contributions to your 401(k) or employer-sponsored plan do not warrant a direct tax deduction on your annual return, these pre-tax deferrals decrease your taxable income, thereby potentially lowering your total tax liability.
Are 401(k) Plans Insured by the FDIC?
Not all 401(k) investments are FDIC-insured. FDIC insurance applies under specific conditions, such as accounts where participants direct how the funds are invested.
The Bottom Line
Retirement savings are a critical aspect of financial planning. Employer-sponsored plans like a 401(k) afford the ability to contribute pre-tax dollars, reducing taxable income and perhaps even lessening annual tax burdens. Employer matches further enrich these arrangements by providing additional funds at no extra cost to the employee. However, remember to adhere to contribution limits to avoid corrective measures and penalties.
Related Terms: salary-deferral contribution, salary-reduction contribution, pre-tax contributions, after-tax contributions, Roth 401(k).
References
- Internal Revenue Service. “401(k) Plan Fix-It Guide - 401(k) Plan - Overview”.
- Internal Revenue Service. “How Much Salary Can You Defer if You’re Eligible for More Than One Retirement Plan?”
- Internal Revenue Service. “401(k) Limit Increases to $23,000 for 2024, IRA Limit Rises to $7,000”.
- Internal Revenue Service. “401(k) Plan Overview”.
- Internal Revenue Service. “401(k) Resource Guide - Plan Participants - General Distribution Rules”.
- Internal Revenue Service. “Retirement Plans FAQs on Designated Roth Accounts”.
- Internal Revenue Service. “Retirement Plan and IRA Required Minimum Distributions FAQs”.
- Internal Revenue Service. “Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits”.
- Internal Revenue Service. “Operating a 401(k) Plan”.
- Internal Revenue Service. “2024 Limitations Adjusted as Provided in Section 415(d), etc”. Pages 1-2.
- Federal Deposit Insurance Corporation. “Your Insured Deposits”. Page 6.
