What Is an Annual Addition?
The annual addition is the total dollar amount contributed in a given year to a participant's retirement account under a defined-contribution plan (DC plan). The annual addition is subject to a maximum limit. This annual addition limit is the lesser of 100% of the participant's compensation for the year or the dollar limit in effect for the year. This limit is $57,000 in 2020.
- There is a limit to the amount an individual can contribute to their defined-contribution retirement plan.
- The most common defined-contribution plan is the 401(k).
- The annual limit for total contributions in 2020 is $57,000.
Understanding Annual Additions
Annual additions apply to defined-contribution plans. These types of retirement plans are typically tax-deferred, yet withdrawals are taxable. Annual additions apply to the total of:
- Elective deferrals (but no catch-up contributions)
- Employer matching contributions
- Employer nonelective contributions
- Allocations of forfeitures
The tax-advantaged status of defined-contribution plans generally allows balances to grow larger over time compared to taxable accounts. The DC plan examples include the 401(k) and the 403(b), in which employees contribute a fixed amount or a percentage of their paychecks. In order to help retain and attract top talent, a sponsor company will generally match a portion of employee contributions in a DC plan. DC plans restrict when and how each employee can withdraw funds without penalties.
Other features of many defined-contribution plans include automatic participant enrollment, automatic contribution increases, hardship withdrawals, loan provisions and catch-up contributions for employees age 50 and older.
Annual Additions and Vesting Periods
When beginning with a new employer, an employee must often wait a period of years to begin receiving annual additions to her retirement plan. Although she can often begin contributing sooner, this benefit is often delayed to ensure that the employee stays in the position long enough to begin adding value and that it’s worth the employer’s time to invest in her. Vesting periods or a vesting schedule is usually determined in the job negotiation phase.
This is common in many start-up environments, where vesting with stock bonuses can help sweeten the pot for a valued employee to remain with the company. For example, an employee’s stock could become 25% vested in the first year, 25% the second year, 25% the third year, and fully vested after four years. If the employee leaves after just two years, she could forfeit 50% of her vesting capabilities.