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 his or her employer matches. The employee may make additional annual voluntary contributions up to certain approved amounts by the Internal Revenue Service (IRS).

Key Takeaways

  • An additional voluntary contribution is an employee contribution beyond the employer's matching contributions to a retirement plan.
  • Excessive contributions will trigger a 6% excess contribution tax, once the funds are withdrawn upon retirement.
  • In 2020 and 2021, the contribution limit for 401(k) plans is $19,500, plus an additional $6,500 for those aged 50 and over.
  • In 2020 and 2021, the contribution limit for IRA accounts is $6,000, plus an additional $1,000 for employees aged 50 and over.

Understanding Additional Voluntary Contributions (AVCs)

Employees can make additional voluntary contributions to tax-deferred savings accounts such as 401(k), 403(b), SEP-IRA, SIMPLE IRA, and Roth 401(k) plans. All but the Roth IRAs 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, the income taxes are paid at the time contributions are made, meaning they are not pretax contributions. However, Roth IRAs 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 2020 and 2021, the maximum employee contribution limit per year is $19,500. If you are aged 50 or older, an additional catch-up contribution of $6,500 for both 2020 and 2021 is allowed. SIMPLE IRAs have a $13,500 employee contribution limit in 2020 and 2021. 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 2020 and 2021 to IRAs. For those aged 50 and over, they can contribute an additional $1,000 as a catch-up contribution.

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 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.

The IRS may impose a tax on excess contributions, which are those offerings that go beyond the additional voluntary contribution limit.

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.