Elective-Deferral Contribution

What Is an Elective-Deferral Contribution?

An elective-deferral contribution is made directly from an employee's salary to his or her employer-sponsored retirement plan such as a 401(k) or 403(b) plan. The employee must authorize the transaction before the contribution can be deducted.

Elective deferrals can be made on a pre-tax or after-tax basis if an employer allows them. The Internal Revenue Service (IRS) establishes limits on how much an employee can defer or contribute to a qualified retirement plan. An elective-deferral contribution is also known as a salary-deferral or salary-reduction contribution.

Key Takeaways

  • An elective-deferral contribution is a portion of an employee's salary that's withheld and transferred into a retirement plan such as a 401(k).
  • Elective deferrals can be made on a pre-tax or after-tax basis if an employer allows.
  • The IRS limits how much you can contribute to a qualified retirement plan.
  • Individuals under the age of 50 can contribute up to $19,500 into a 401(k) in 2021 and $20,500 in 2022.
  • People 50 and above can make catch-up contributions of an additional $6,500 for a total of $26,000.

How an Elective-Deferral Contribution Works

Elective-deferral contributions made into traditional 401(k) plans are made on a pre-tax or tax-deferred basis, effectively reducing an employee's taxable income. Suppose an individual making $40,000 a year decides to contribute $100 per month into their 401(k). These deferrals total $1,200 per year. As a result, the employee's pay is taxed at $38,800 that year instead of $40,000. 

Since there's a tax-deduction upfront, any distributions are taxed at the income tax rate for the retiree at the time of withdrawal. Several restrictions apply as to when and under what circumstances an employee can make withdrawals from an employer-sponsored retirement plan. For example, an additional 10% penalty tax may apply if an individual makes a withdrawal before age 59½—assuming the employee meets the conditions that allow him or her to take an early distribution. State and local taxes may also be assessed for early withdrawals.

Some employers allow workers to contribute toward Roth 401(k) plans. Contributions made to these plans are made on an after-tax basis. After tax-basis means the funds are taxed before they were deposited into the retirement plan. Since there's no pre-tax benefit with Roth 401(k)s, employees can withdraw deferrals tax-free as long as they're over the age of 59½.

Unlike Roth IRAs, Roth 401(k)s are not subject to RMDs during the owner's lifetime.

Elective-Deferral Contribution Limits

The IRS has limits on how much money can be contributed to an employee's qualified retirement plan.

Employee Contribution Limit

For 2021 and 2022, individuals under the age of 50 can contribute up to $19,500 and $20,500 into a 401(k). Those aged 50 and above can make catch-up contributions of an additional $6,500 for a total of $26,000 and $27,000. These rules apply to Roth 401(k)s as well.

IRS rules also apply if you have multiple 401(k) accounts. This means if a person under 50 invests in a traditional 401(k) and a Roth 401(k) plan, they can make elective-deferral contributions of up to $19,500 for 2021 and $20,500 for 2022.

Employee and Employer Total Contribution Limit

The rules stated earlier apply only to elective-deferral contributions. They do not apply to the matching contributions from an employer, nonelective employee contributions, or any allocations of forfeitures. The IRS limits the total amount that can be contributed to an employee's retirement plan from all sources, including the employer's matching and the employee's contributions.

The total contributions to an employee's retirement plan from both the employee and employer cannot exceed the lesser of:

  • 100% of the participant's compensation
  • $58,000 or $64,500, including catch-up contributions for those aged 50 and over in 2021
  • $61,000 or $67,500, including catch-up contributions for those aged 50 and over in 2022

Article Sources

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Internal Revenue Service. "Retirement Topics - Contributions." Accessed Nov. 18, 2021.

  2. Internal Revenue Service. "IRS Announces 401(k) Limit Increases to $20,500." Accessed Nov. 18, 2021.

  3. Internal Revenue Service. "Retirement Topics - Catch-Up Contributions." Accessed Nov. 18, 2021.

  4. Internal Revenue Service. "401(k) Plan Overview." Accessed Nov. 18, 2021.

  5. Internal Revenue Service. "401(k) Resource Guide - Plan Participants - General Distribution Rules." Accessed Nov. 18, 2021.

  6. Internal Revenue Service. "Retirement Plans FAQs on Designated Roth Accounts." Accessed Nov. 18, 2021.

  7. Internal Revenue Service. "Retirement Plan and IRA Required Minimum Distributions FAQs." Accessed Nov. 18, 2021.

  8. Internal Revenue Service. "How Much Salary Can You Defer if You’re Eligible for More than One Retirement Plan?" Accessed Nov. 18, 2021.

  9. Internal Revenue Service. "Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits." Accessed Nov. 18, 2021.

Take the Next Step to Invest
×
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.
Service
Name
Description