Contributions to a traditional IRA, Roth IRA, 401(k), or other retirement savings plan are limited by the Internal Revenue Service (IRS) to prevent highly paid workers from benefiting 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 that person earns.

Key Takeaways

  • Contributions to retirement plans are capped 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.
  • In some instances, contributions are not allowed for people who are considered high earners by the IRS.

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 investments in these accounts grow tax-deferred, but withdrawals will be 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-deferred, but unlike traditional retirement accounts, withdrawals are not taxed. Roth plans are particularly beneficial to people who will be in a high tax bracket in 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 2020, the maximum contribution to a 401(k) plan, either traditional or Roth, for employees under age 50 is $19,500 ($19,000 for 2019). Employers can also contribute through either non-elective deferrals or contribution matching. However, the total contribution from all sources must not exceed the lesser of the employee's compensation or $57,000 ($56,000 for 2019).

If you have both a traditional and a Roth 401(k), the total of all your contributions to both accounts cannot exceed $19,500 for 2020 ($19,000 for 2019), or $26,000 ($25,000 for 2019) if you are age 50 or over.

To encourage workers who are nearing the end of their careers to put away even more, the IRS allows additional catch-up contributions for anyone 50 or over. For 2020, the catch-up contribution is $6,500 ($6,000 for 2019), and the total contribution limit from all sources is $63,500 ($62,000 for 2019).

As long as you keep working at your employer, 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 $120,000—must not exceed a certain percentage of the average contribution made by non-highly paid 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 are allowed to contribute increases, up to the annual maximum.

IRA Contribution Limits

For 2019 and 2020, IRA participants 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. If you are still earning eligible income at age 70½, you can continue to contribute to a Roth IRA, but not to a traditional IRA.

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're 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 and 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 their spouse is covered by an employer-sponsored plan, or if their combined income is above a certain amount.

In addition, Roth IRA contributions are phased out for people making above a certain amount. In 2020, a single person whose modified adjusted gross income (MAGI) is more than $124,000 ($122,000 for 2019), or marrieds who file jointly and whose income exceeds $196,000 ($193,000 for 2019), can make only reduced contributions. Individuals who earn more than $139,000 ($137,000 for 2019), and couples who earn more than $206,000 ($203,000 for 2019), are not eligible to contribute to Roth IRAs at all.