The 401k annual limit on compensation is one of the least understood limits, but it’s just as important to comprehend as all the others.
The good news is that it’s not really difficult to understand. All this rule does is limit the amount of your compensation that can be taken into account when determining how much you can contribute to your account. For 2012, the annual limit on compensation is $250,000
Annual Compensation Limit
Here’s an example.
Let’s say that you make $350,000 a year, and your employer matches your contributions 100% up to the first 3% you contribute. Without any limitations, that means you would receive a match of $10,500 ($350k * .03) if you contributed at least 3% of your salary, right?
But…the IRS caps the amount of your compensation that can be taken into consideration to $250,000 in 2008. This means that you could receive a maximum of only $7,500 ($250k * .03). Big difference, right?
You might be asking why the IRS would create 401k contribution limits such as this.
Well, this can be a couple of reasons. Since employer contributions are tax deductible, the IRS wants to limit the amount of a tax breaks your employer could receive, so they limit the amount that your employer could put into your account.
But also remember that qualified plans, like 401k’s, are intended to be fair and equitable for all, regardless of income. Based on those grounds, it wouldn’t be “fair” for someone who makes more money to receive a substantially larger matching contribution. So, they solve that problem by limiting your eligible compensation.
Below is the current and past thresholds for the 401k annual limit on compensation:
|401k Plan Limits for Plan Year||2012||2011||2010||2009||2008||2007||2006|
|401k Elective Deferrals||$17,000||$16,500||$16,500||$16,500||$15,500||$15,500||$15,000|
|Annual Defined Contribution Limit||$50,000||$49,000||$49,000||$49,000||$46,000||$45,000||$44,000|
|Annual Compensation Limit||$250,000||$245,000||$245,000||$245,000||$230,000||$225,000||$220,000|
|Catch-Up Contribution Limit||$5,500||$5,500||$5,500||$5,500||$5,000||$5,000||$5,000|
|Highly Compensated Employees||$115,000||$110,000||$110,000||$110,000||$105,000||$100,000||$100,000|
You can also find information on the 401k annual limits at this website.