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

Retirement account limits were meant to help the average worker save

Contributions to a traditional individual retirement account (IRA), Roth IRA, 401(k), and other retirement savings plans are limited by law so that highly paid employees don’t benefit more than the average worker from the tax advantages that they provide. Contribution limits vary by the type of plan, the age of the plan participant, and, in some instances, how much the person earns.

Key Takeaways

  • Contributions to individual retirement accounts (IRAs) and 401(k) accounts are capped by law, in part so that high earners won’t benefit more than the average worker.
  • The contribution limits vary by the type of plan and the age of the plan participant.
  • These contribution and income limits are subject to change each year, based on inflation.

IRA and 401(k) Tax Advantages

Contributions to traditional IRA and 401(k) accounts are made with pretax dollars, which can significantly reduce the worker’s taxable income 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 held in Roth accounts also grow tax deferred, but unlike traditional retirement accounts, qualified distributions (withdrawals) are tax free.

Both traditional and Roth contributions are capped so that higher-paid workers who can afford to defer large amounts of their compensation can’t take undue advantage of these tax benefits—at the expense of the U.S. Treasury.

Here are the current rules, starting with 401(k) plans.

401(k) Contribution Limits

For 2022, the maximum individual contribution to a 401(k) plan, either traditional or Roth, is $20,500 for employees under age 50. Those older than 50 can make an additional catch-up contribution of $6,500, for a total of $27,000.

Employers can also contribute to the employee’s account by making matching contributions or nonelective contributions.

The total contribution limit from all sources in 2022 is either 100% of the employee’s compensation or $61,000 ($67,500 if the employee makes catch-up contributions), whichever is less.

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

Nondiscrimination Testing: 401(k)s Only

In the case of 401(k) plans, the Internal Revenue Service (IRS) imposes limits 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 larger salaries—more than $135,000 for 2022—must not exceed a certain percentage of the average contribution made by other employees.

This is intended, in part, to prompt higher-level employees, such as executives and managers, to encourage plan participation among lower-paid workers. As the average employee contribution increases, the amount that more highly compensated employees can contribute also rises, up to the annual maximum.

Note

Prior to 2020, eligibility to contribute to a traditional (but not Roth) IRA stopped at age 70½. The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 eliminated that restriction.

IRA Contribution Limits and Other Rules

IRAs were first introduced in the 1970s to help workers without regular pensions save for retirement, not as a tax shelter for the rich. They have always had certain limits based on income, though those can change from year to year.

For 2022, taxpayers who are under age 50 are limited to a maximum annual IRA contribution of $6,000, or 100% of their compensation, whichever is less. Those 50 and older can make additional catch-up contributions of up to $1,000. This limit applies to both traditional and Roth IRAs. Someone who has both types of IRA can split their contributions between the two types of accounts, but they can’t exceed the $6,000 or $7,000 limit in total.

Although they share the same contribution limits, traditional and Roth IRAs are subject to different rules on who can contribute to them and how much they can contribute or deduct.

Traditional IRA Contribution Rules

Anyone, regardless of their income, can contribute to a traditional IRA. However, the extent to which they can take a tax deduction for their contributions depends on their income and whether they (or their spouse) are covered by another retirement plan at work.

For example, in 2022, someone with another retirement plan whose modified adjusted gross income (MAGI) is under $109,000 and who files a joint tax return with their spouse would be eligible for a full deduction for their contribution to a traditional IRA. They would be eligible for a partial deduction if their income is $109,000–$129,000. Above that amount, they still could contribute to a traditional IRA but wouldn’t get any deduction.

If that same person did not have another retirement plan, they would be eligible for a full deduction if their income was less than $204,000 and a partial deduction with an income in the $204,000–$214,000 range.

Roth IRA Contribution Rules

Unlike traditional IRAs, Roth IRAs do have income limits on whether a taxpayer is eligible to contribute. (This has led to a two-step tactic called a backdoor Roth IRA, in which wealthy taxpayers first contribute to a traditional IRA and then convert it into a Roth.)

For example, in 2022, a taxpayer who is married and files a joint tax return can make a full Roth IRA contribution if their MAGI is less than $204,000 and a partial contribution if their MAGI is in the $204,000–$214,000 range. Above $214,000, they are ineligible.

Are there income limits for contributing to a Roth 401(k)?

No. Unlike Roth individual retirement accounts (IRAs), there are no income limits on your eligibility to contribute to a Roth 401(k), sometimes referred to as a designated Roth 401(k).

What is a qualified distribution from a Roth individual retirement account (IRA)?

A qualified distribution from a Roth IRA is a withdrawal that meets the requirements for being tax free. To qualify, the account owner must have had a Roth IRA for at least five years. As with traditional IRAs, Roth IRA distributions also can be subject to 10% early withdrawal penalties if the account owner is under age 59½ at the time (although there are exceptions).

Are backdoor Roth IRAs legal?

Yes, despite some efforts in Washington to limit or eliminate them—including in the Build Back Better Act passed by the U.S. House in 2021, but not by the U.S. Senate—they remain legal as of March 2022.

The Bottom Line

Contributions to IRAs and 401(k) plans are limited in certain ways, in part to level the playing field between high-income taxpayers and those with less income. The rules on traditional IRAs, Roth IRAs, and 401(k) accounts differ in certain key respects, and high-income taxpayers are still able to get around the Roth rules by creating a backdoor Roth IRA.

Article Sources
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  1. Internal Revenue Service. “Roth Comparison Chart.”

  2. Internal Revenue Service. “Retirement Topics — 401(k) and Profit-Sharing Plan Contribution Limits.”

  3. Internal Revenue Service. “401(k) Plan Qualification Requirements.”

  4. Internal Revenue Service. “401(k) Plan Fix-It Guide — The Plan Failed the 401(k) ADP and ACP Nondiscrimination Tests.”

  5. U.S. Congress. “H.R.1994 — Setting Every Community Up for Retirement Enhancement Act of 2019.”

  6. Internal Revenue Service. “Retirement Topics — IRA Contribution Limits.”

  7. Internal Revenue Service. “2022 IRA Contribution and Deduction Limits Effect of Modified AGI on Deductible Contributions If You ARE Covered by a Retirement Plan at Work.”

  8. Internal Revenue Service. “2022 IRA Contribution and Deduction Limits Effect of Modified AGI on Deductible Contributions If You are NOT Covered by a Retirement Plan at Work.”

  9. Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2022.”

  10. Internal Revenue Service. “Topic No. 557 Additional Tax on Early Distributions from Traditional and Roth IRAs.”

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