Why IRA, Roth IRA, and 401(k) Contributions Are Limited

Contributions to a traditional IRA, Roth IRA, 401(k), and other retirement savings plans are limited by the Internal Revenue Service (IRS) to prevent highly paid workers from benefitting more than the average worker from the tax advantages they provide.

Contribution limits vary by the type of plan, the age of the plan participant, and in some instances, by how much the person earns.

Retirement Plan Tax Advantages

Contributions to traditional IRA and 401(k) accounts are made with pretax dollars, which can significantly reduce the worker’s income tax burden for the year. The money in these accounts grows tax-deferred, but withdrawals are subject to income tax.

By contrast, Roth IRA and Roth 401(k) contributions are made with after-tax dollars. Investments in Roth accounts also grow tax-free, but unlike traditional retirement accounts, qualified withdrawals are not taxed. Roth plans are particularly beneficial because they can help you pay less money in taxes during retirement.

Both traditional and Roth contributions are capped so that higher-paid workers who can afford to defer large amounts of their compensation do not take undue advantage of these tax benefits.

401(k) Contribution Limits

For 2021, the maximum contribution to a 401(k) plan, either traditional or Roth, for employees under age 50 is $19,500 ($20,500 for 2022). Employers can also contribute through either elective deferrals or contribution matching.

However, the total contribution from all sources must not exceed the lesser of the employee’s compensation or $58,000 in 2021 ($61,000 for 2022).

To encourage workers who are nearing the end of their careers to put away more money, the IRS allows additional catch-up contributions for anyone age 50 or over. For 2021 and 2022, the catch-up contribution is $6,500, and the total contribution limit from all sources is $64,500 ($67,500 for 2022).

As long as you keep working, you can continue to contribute to either type of 401(k), no matter how old you are.

Non-Discrimination Testing: 401(k)s Only

In the case of 401(k) plans, the IRS imposes limitations on the contributions of highly compensated employees. Referred to as nondiscrimination testing, these rules are intended to encourage equal participation across all compensation levels.

For a 401(k) plan to retain its qualified status, contributions made by employees who earn large salaries—more than $130,000 for 2021 ($135,000 for 2022)—must not exceed a certain percentage of the average contribution made by other employees.

This prompts higher-level employees, such as executives and managers, to encourage plan participation among the rank and file. As the average regular employee contribution increases, the amount that more highly compensated employees can contribute increases, up to the annual maximum.

IRA Contribution Limits

For tax years 2021 and 2022, investors in IRA accounts who are under age 50 are limited to a maximum contribution of $6,000, or 100% of their compensation, whichever is less. Those age 50 and over can make additional catch-up contributions of up to $1,000 annually.

Prior to 2020, if you were still earning eligible income at age 70½, you could continue to contribute to a Roth IRA, but not to a traditional IRA. The Setting Every Community Up for Retirement Enhancement (SECURE) Act, signed into law at the start of 2020, allows people who are working to continue contributing to an IRA regardless of age.

Like 401(k) plans, the annual contribution limits for IRAs apply to all accounts held by the same person. If you have both a traditional and a Roth IRA, the total of all your contributions to both accounts cannot exceed $6,000, or $7,000 if you are 50 or over.

Leveling the Playing Field

Because they aren’t offered through employers, IRAs are not subject to the type of nondiscrimination testing that applies to 401(k) contributions.

However, IRAs were developed to encourage the average worker to save for retirement, not as another tax shelter for the rich. To prevent unfair benefit to the wealthy, the contributions to a traditional IRA that are tax-deductible may be reduced if the account holder or spouse is covered by an employer-sponsored plan, or if their combined income is above a certain amount.

Also, Roth IRA contributions are phased out for people whose modified adjusted gross income (MAGI) is above a certain level.

Reduced contributions to Roth IRAs are allowed for:

• Single filers with MAGIs from $125,000 to less than $140,000 for 2021 ($129,000 to $144,000 for 2022)
• Married couples filing jointly earning $198,000 to less than $208,000 in 2021 ($204,000 to $214,000 in 2022)

Roth IRA contributions are not allowed for:

• Single filers earning $140,000 or greater in 2021 ($144,000 in 2022)
• Married couples filing jointly earning $208,000 or greater in 2021 ($214,000 in 2022)

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