If you’ve ever wondered if you could be making too much money to contribute to your employer’s sponsored retirement plan, chances are that you don’t need to worry. Unlike a Traditional or Roth IRA, there are no upper 401k income limits that will keep you from contributing. This makes it a very attractive option when you are considering the benefits between the IRA vs 401k.
The only restriction is if you are a highly compensated employee (more on this below).
In contrast, an IRA is limited by an individual’s modified adjusted gross income (MAGI). If you make too much money, you either won’t be allowed to contribute to a Roth IRA or you won’t be able to take the deduction from a Traditional IRA. However, this is not the case with your 401k plan.
For a 401k, your employer simply just has to offer it as a fringe benefit, similar to health, dental, vision or life insurance coverage. If they do and you meet certain age eligibility requirements, then you’ll likely be able to participate – regardless of how much you make.
This can be used to your advantage if you make too much money to contribute to a Roth IRA. While you still have the option to contribute to a Traditional IRA and let your money grow tax free, you won’t be able to take the up-front tax deduction. But with your 401k, you will get both the up-front tax deduction (from not including it as part of your taxable income on your income taxes) and your money will grow tax-free.
Therefore, if you find yourself in a situation with money to save but you can’t invest in a Roth IRA, you may want to consider maxing out your 401k plan as the alternative.
The IRS does have at least one rule that applies to the top income earners that may inhibit how much they’re allowed to put in their 401k plan. According to their definition, you might be considered a “highly compensated employee” or HCE if you are an individual who:
Owned more than 5% of the interest in the business at any time during the year or the preceding year, regardless of how much compensation that person earned or received, or
For the preceding year, received compensation from the business of more than $115,000 (if the preceding year is 2012), and, if the employer so chooses, was in the top 20% of employees when ranked by compensation.
This is intended to limit discrimination against the lower income earners (non-highly compensated employees or NHCE). The average deferral percentage of the all HCE’s as a group can be no more than 2 percentage points greater (or 125% of, whichever is more) than the NHCEs as a group.
Minimum 401k Income Limits:
Just like an IRA, part of being able to contribute to a 401k is having taxable compensation (i.e. you made money by working for an employer and paid taxes on it). If you’re a lower income earner, the IRS says you cannot contribute more to your 401k plan than you earned in a single year.
For example, if you only made $10,000 in taxable compensation, then you cannot contribute more than $10,000 to your 401k plan.
Even with the potential for your contributions to be limited if you are a highly compensated employee, the fact that there are virtually no 401k income limits makes this a favorable choice when you have to prioritize among your options.
However, keep in mind that the best solution is to benefit by using both an IRA and 401k whenever possible. Therefore you should take a moment to make sure you understand the IRA income limits and see you are eligible to contribute or not.
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