Income Limits for 401(k)s: Highly Compensated Employees

A number of limits can apply to employer-sponsored 401(k) plans such as maximum annual employee and employer contribution limits. Some of these limits apply to 401(k) contributions of employees who earn high salaries or to employers that are generous with their matching contributions.

Here, we’ll explain more about the 401(k) limits for highly compensated employees (HCEs), including how they work.

What Are Highly Compensated Employees?

Highly compensated employees (HCEs) are employees who earn more than the Internal Revenue Service (IRS) maximum allowable compensation for a 401(k) of $150,000 ($135,000 in 2022), or who own more than 5% of a business. Employers can also voluntarily designate the top 20% of earners in the firm as HCEs.

For most employees, the most relevant limit that applies to a 401(k) is what the IRS calls the salary deferral limit. This is the amount of money that you can put into your 401(k) every year, and on which you don’t pay tax until you withdraw it in retirement. In 2023, this limit is $22,500 if you are under age 50, and $30,000 if you are 50 or older (including the catch-up contribution of $7,500).

Other limits that the IRS places on 401(k) plans apply only to HCEs. Not all 401(k) plans have HCE participants. But for those that do, HCEs affect the way that a plan works in several ways.

First, the IRS requires that all 401(k) plans take a nondiscrimination test every year. By examining the contributions made by HCEs, the test determines whether all employees are treated equally through the company’s 401(k) plan. These nondiscrimination stipulations are in place so that employee retirement plans do not discriminate in favor of HCEs.

Income and Contribution Limits for 401(k) Plans

There are two main types of income limit for 401(k) plans that mainly apply to HCEs: matching contribution limits and absolute limits. Let’s look at how both limits can affect HCEs. 

Matching Contribution Limits

HCEs can face a 401(k) limit on the amount of income on which their employer can offer a contribution match. This limit is $330,000 in 2023, up from $305,000 in 2022.

Here’s an example of when this limit would apply. Suppose your annual salary is $500,000, and your employer’s policy is to match 100% of your contributions, up to 5% of your total compensation. You then contribute the IRS limit of $22,500 (since this limit is not affected by your income). At this point, you would expect your employer to match your contribution of $22,500, since this is less than 5% of your income.

But this is where the matching contribution limit applies. Because the IRS limits the amount of income that your employer can match, you can only receive matching contributions on 5% of $330,000. This means that your employer would contribute $16,500, not $22,500.

Absolute Limits

The second type of income limit that’s relevant here is an absolute limit on the amount that can be added to your 401(k) per year from all sources. In 2023, this limit is either 100% of your salary or $66,000 if you are under age 50. If you're 50 or older, you have an absolute limit of $73,500 or 100% of your salary.

In practice, this limit only applies to two types of employees:

• HCEs whose employer has a very generous 401(k) plan
• Self-employed individuals who are both the employer and employee for a solo 401(k) plan
  

Therefore, it’s possible that a generous employer could contribute $60,000 to an employee’s 401(k) in a given year as a non-matching contribution. In this case, the employee themselves could contribute only an extra $6,000 to their plan if they were less than 50.

The Bottom Line

Several income limits apply to 401(k) plans, including limits that mainly apply to highly compensated employees, also known as HCEs. HCEs are employees who earned more than $150,000 in 2023, or who own more than 5% of a business.

The IRS limits the amount of income on which an employer can offer a matching contribution to $330,000 in 2023. There is also an absolute limit of $66,000 on the total of all contributions to a 401(k) plan. These limits only apply to a small percentage of employees.