What Is an Additional Voluntary Contribution (AVC)?
An additional voluntary contribution (AVC) is a term describing an employee's tax-deferred payment to a retirement savings account that exceeds the amount their employer matches. The employee may make additional annual voluntary contributions up to certain approved amounts by the Internal Revenue Service (IRS).
- An additional voluntary contribution is an employee contribution beyond the employer's matching contributions to a retirement plan.
- Excessive IRA contributions will trigger a 6% excess contribution tax once the funds are withdrawn upon retirement.
- In 2022, the contribution limit for 401(k) plans is $20,500 (increasing to $22,500 in 2023), plus an additional $6,500 for those aged 50 and over (increasing to $7,500 in 2023).
- In 2022, the contribution limit for IRA accounts is $6,000 (increasing to $6,500 in 2023), plus an additional $1,000 for employees aged 50 and over.
Understanding an Additional Voluntary Contribution (AVC)
Employees can make additional voluntary contributions to tax-deferred savings accounts such as 401(k), 403(b), SEP-IRA, and SIMPLE IRA plans. Roth IRAs and designated Roth accounts don't allow the employee to contribute pretax dollars.
This essentially means that employees may postpone paying income taxes on this portion of their salaries until they withdraw the money upon retirement. With Roth IRAs and designated Roth accounts, the income taxes are paid at the time contributions are made, meaning they are not pretax contributions. However, Roth's allow tax-free withdrawals or distributions in retirement.
Employer Matching Contributions
With employer-sponsored retirement plans, employers can match the percentage of the salary that an employee contributes, up to a threshold. For example, an employer might contribute 3% of an employee's salary each year.
The employer might require that the employee also contribute a minimum percentage in order to qualify for the employer match. In some cases, companies offer programs with higher matching maximums, while others offer no matching options of any kind.
Employee Contribution Limits
The IRS has established annual contribution limits for 401(k)s. For 2022, the maximum employee contribution limit per year is $20,500 (increasing to $22,500 in 2023). If you are aged 50 or older, an additional catch-up contribution of $6,500 is allowed (increasing to $7,500 in 2023).
SIMPLE IRAs have a $14,000 employee contribution limit in 2022 (increasing to $15.500 in 2023). The catch-up contribution is $3,000 (increasing to $3,500 in 2023). SIMPLE IRAs are plans that are offered by companies with fewer than 100 employees.
The contribution limits for employer-sponsored retirement plans are much higher than the limits for individual retirement accounts (IRAs) and individual Roth IRAs. Per the IRS, individuals can contribute a maximum of $6,000 in 2022 to IRAs (increasing to $6,500 in 2023). For those aged 50 and over, they can contribute an additional $1,000 as a catch-up contribution.
The IRS may impose a tax on excess contributions, which are those offerings that go beyond the additional voluntary contribution limit.
In the above employee contribution limits, they do not include employer contributions. If an employer, for example, contributed to an employee's plan 5% of the employee's $50,000 salary, they would add $2,500 to the employee's 401(k).
Let's say that the employee was also required to add 5% of their salary to qualify for the employer match. Any additional employee contributions beyond the employer match of 5% would be considered additional voluntary contributions.
Tax Consequences of Excess Contributions
Additional voluntary contributions may vary in tax treatment, depending on the type of plan. Typically, contributions made to tax-deferred accounts will accumulate or grow tax-free until retirement.
When the funds are withdrawn for retirement, the IRS will levy a 6% tax on the extra amount contributed, and on any investment returns earned by that money every year until then.
What Is the Contribution Limit for a 401(k) Plan?
The contribution limit for a 401(k) plan is $12,500 in 2022. This increases to $22,500 in 2023. For 2022, an additional $6,500 catch-up contribution is allowed if you are aged 50 or older, increasing to $7,500 for 2023.
What Is the Contribution Limit for an IRA?
For both a traditional IRA and a Roth IRA, the contribution limit in 2022 is $6,000, increasing to $6,500 in 2023. If you are aged 50 or older, an additional $1,000 catch-up contribution is allowed.
What Are Voluntary Contributions to a 401(k)?
Voluntary contributions to a 401(k) are additional contributions made by you to your 401(k) account that is funded with after-tax dollars, meaning you do not receive the tax-advantage benefits of a 401(k) on those voluntary contributions.