Demystifying 401(k) Plan Contributions

Whether you are just starting your career or well on your way, understanding how 401(k)s work and the benefits they offer can help strengthen your financial future.

Before we dive into the technical aspects, let’s cover a few basic concepts about 401(k)s.

Essential Concepts to Embrace

Contributions: You decide how much of each paycheck goes into your 401(k) account, giving you the power to set a savings pace that suits your financial goals.

Employer Match: If your company offers to match a portion of your contributions, take advantage of it. An employer match can significantly enhance your retirement savings because your employer contributes additional funds based on your contributions, subject to the terms of the plan.

Vesting: If your company matches your contributions, it may have a vesting schedule. This means that while the money you contribute is always yours, you may need to wait for a period of time before the employer match fully belongs to you (vests).

Investment Choices: Your plan provides various investment options, from conservative to growth-oriented, giving you the chance to create a diversified portfolio that matches your risk tolerance.

Tax Benefits: You do not pay taxes on money contributed to your 401(k) until you withdraw it, giving you a tax break now and allowing your money to grow without annual tax payments. Some plans allow Roth contributions to 401(k)s, which are taxed now and allow for tax-free growth and, assuming qualifications are met, tax-free withdrawals on the deposited funds, including earnings. If both options are available, consult your financial advisor to determine which option is best for your specific circumstances.

Example:

Let’s walk through an example illustrating how someone can contribute to their 401(k) and reach the annual contribution limit, including elective deferrals, employer match, and after-tax contributions.

Meet Sarah, a 45-year-old marketing director at a thriving tech company. She is a dedicated employee who understands the importance of planning for her retirement. Here is how Sarah helps to maximize her 401(k) contributions and reach the annual limit.

Sarah’s Situation

• Sarah’s annual salary: $405,000
• Employer match: 100% of the first 6% of salary

Sarah’s Strategy

Elective Deferrals: Sarah decides to contribute the maximum allowed elective deferral of $24,500 (for 2026) from her pre-tax salary. This strategy may reduce her taxable income for the current year and can help build her retirement savings.

At first glance, Sarah might assume that a contribution rate of about 6% would allow her to reach the $24,500 elective deferral limit. However, because the plan must also apply the IRS annual compensation limit when determining certain plan benefits and contributions, high earners may need to pay close attention to how their own plan and payroll system calculate percentage-based deferral elections. In Sarah’s case, if her plan applies her deferral percentage only to the first $360,000 of compensation, she would need to elect approximately 7% to reach the $24,500 elective deferral limit.

Employer Match: Sarah’s employer offers a 100% match on the first 6% of her salary. However, since her salary exceeds the IRS compensation limit, her employer bases the match on the first $360,000 of her income. Because Sarah contributes at least 6% ($24,500), she receives the full employer match, adding $21,600 to her retirement account.

After-Tax Contributions: The total annual contribution limit for all sources (elective deferrals, employer contributions, and after-tax contributions) is $72,000. Sarah decides to contribute an additional $25,900 as an after-tax contribution to reach this limit.

Some plans will allow what is known as a “mega backdoor Roth conversion.” This strategy allows participants to convert after-tax plan contributions to Roth assets, allowing tax-free growth on the funds going forward.

The Calculation:

• Compensation limit: $360,000
• 6% of compensation: $21,600 (this is the maximum amount eligible for employer match)
• After-tax contribution to reach limit: $72,000 – $24,500 (elective deferral) – $21,600 (employer match) = $25,900

Sarah’s Total Contributions:

• Elective deferral: $24,500
• Employer match: $21,600
• After-tax contribution: $25,900
• Total contributions: $72,000

By understanding the various limitations the IRS imposes, Sarah is able to maximize her 401(k) contributions even with her salary above the compensation limit. While the compensation limit affects her employer match eligibility, she can still contribute via elective deferrals and after-tax contributions to reach the overall contribution limit. In some cases, employers offer what is known as a “401(k) restoration plan” to restore benefits that high-earning employees lose because their incomes exceed the compensation limit.

Understanding Contribution Limits

The example above touches on several different limits and IRS regulations. The sections below explain elective deferral limits, the “415 limit,” and compensation limits, which will help you understand not only the example above but also your own 401(k) plan and contributions.

Elective Deferrals: Each year, the IRS sets a maximum amount you can contribute to your 401(k) through what is known as an “elective deferral.” An elective deferral is the amount a 401(k) plan participant contributes to their account on a tax-deferred basis.

For 2026, if you are below 50, the elective deferral limit is $24,500; if you are 50 or older, you can contribute an additional $8,000 “catch-up contribution” for a total of up to $32,500. For those ages 60 through 63, a “super catch-up contribution” (if available within your plan) allows an additional $11,250, for an annual maximum contribution total of up to $35,750.

415 Limit: The IRS refers to the maximum amount you can contribute to a 401(k) plan from all regular sources, including employee elective deferrals, employer contributions, and after-tax employee contributions, as the “415 limit.” For 2026, that limit is $72,000. Catch-up contributions are separate. Participants age 50 or older may be eligible to contribute an additional $8,000, and participants ages 60 through 63 may be eligible for a higher catch-up contribution of $11,250, if the plan permits it.

Compensation Limits: When making 401(k) contribution elections, it is important to consider the annual compensation limit the IRS applies when calculating 401(k) contributions. For 2026, the annual compensation limit is $360,000. In practice, this means that if you make more than $360,000, the IRS only considers your first $360,000 of income when you make your 401(k) contributions.

Note: Beginning in 2026, certain high-income earners must make catch-up contributions as Roth contributions. According to the IRS, for 2026, the relevant prior-year wage threshold is $150,000.

As always, individual circumstances can vary, and it is important to understand your specific plan’s rules and consult with financial professionals to evaluate retirement savings strategies based on your individual circumstances.

This is intended for informational purposes only. You should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment or tax advice from Savant. Please consult your investment or tax professional regarding your unique situation.