For 2023, 401(k) Contribution Limit Rises to $22,500 with $7,500 ‘Catch-Up’

?Employee 401(k) contributions for 2023 will top off at $22,500—a $2,000 increase from the $20,500 cap for 2022—the IRS announced on Oct. 21. Plan participants age 50 or older next year can contribute an additional $7,500, up $1,000 from 2022.

Inflation is at its highest level since 401(k) annual indexing began, causing 7 percent to 11 percent increases for most 2023 contribution limits. The annual cost-of-living adjustments (COLAs) reflect increases in the Consumer Price Index for All Urban Consumers (CPI-U) from the third quarter of 2021 to the third quarter of 2022.

The CPI-U rose 8.2 percent for the 12 months ending in September, down from the 9.1-percent high notched for the period ending in June but still near a 40-year high, the U.S. Bureau of Labor Statistics reported on Oct. 13.

The annual 401(k) employee contribution limit “usually goes up by $500 at a time but higher inflation is making it go four steps in one year,” commented Harry Sit, CEBS, who edits The Finance Buff blog.

The limit on total employer-plus-employee contributions to defined contribution plans will increase to $66,000 in 2023, up by $5,000 from $61,000 in 2022. “This limit usually increases by $1,000 at a time but now it’s jumping five steps in one year,” Sit said.

The IRS announced the 2023 adjustments for 401(k) and similar defined contribution plans, and for defined benefit pension plan, in Notice 2022-55.

401(k) Contributions

Contribution and income limits rising in 2023 for defined contribution plans are charted below.

Defined Contribution Plans	2023	2022	Change
Maximum employee elective deferral (age 49 or younger) ¹	$22,500	$20,500	+$2,000
Employee catch-up contribution (age 50 or older by year-end) ²	$7,500	$6,500	+$1,000
Maximum employee elective deferral plus catch-up contribution (age 50 or older)	$30,000	$27,000	+$3,000
Defined contribution maximum limit, employee + employer (age 49 or younger) ³	$66,000	$61,000	+$5,000
Defined contribution maximum limit (age 50 or older), all sources + catch-up	$73,500	$67,500	+$6,000
Employee compensation limit for calculating contributions	$330,000	$305,000	+$25,000
Key employees’ compensation threshold for top-heavy plan testing ⁴	$215,000	$200,000	+$15,000
Highly compensated employees’ threshold for nondiscrimination testing ⁵	$150,000	$135,000	+$15,000

¹ The $22,500 elective deferral limit is also known as the 402(g) limit, after the relevant tax code section. Participants’ annual contributions may not exceed 100% of their compensation.

² The $7,500 catch-up contribution limit for participants age 50 or older applies from the start of the year for those turning 50 at any time during the year.

³ Total contributions from all sources may not exceed 100% of a participant’s compensation.

⁴ Includes officers of the company sponsoring the plan.

⁵ For the 2023 plan year, an employee who earned more than $150,000 in 2022 is an HCE.

?Source: IRS Notice 2022-55.

Although these limits were announced as many employers were beginning their open enrollment periods for 2023 benefits, “fortunately, 401(k) contributions can be adjusted during the course of the year and so are less time-sensitive” compared with benefit caps that employees are locked into after their annual enrollment selection, said Kim Buckey, vice president of client services at Optavise, a benefits education, enrollment and health care transparency firm.

Annual Limit as a Contribution Goal

HR professionals should convey to employees their plan contribution limits for next year. Not all plan participants will be able to fund their 401(k) accounts up to the maximum, but the contribution cap is a goal they should keep in mind and may encourage those who can defer extra dollars for retirement savings to do so.

Despite the sharp declines in stock and bond funds this year, 401(k) plans continue to see steady contributions, according to Fidelity Investments’ analysis of 24,000 corporate defined contribution plans it provides services for, with 21.7 million participants, as of June 30.

“Although many Americans are understandably concerned about the economy, record-high inflation and markets at this time, it’s encouraging to see the prevailing emotion has been to stay calm and focused on one’s retirement objectives,” said Kevin Barry, president of workplace investing at Fidelity. “Saving for retirement is a goal that is decades in the making, and there will naturally be many twists and turns. However, the best action savers can take to help achieve success is to consistently save and invest.”

In the second quarter of the year, the total savings rate, which reflects a combination of employee and employee 401(k) contributions, was a 13.9 percent, just below Fidelity’s suggested savings rate of 15 percent. Men continued to save at higher rates than women (14.7 percent vs. 13.7 percent), while pre-retiree Baby Boomers saved at the highest levels (16.6 percent), although even Generation Z participants saved in the double digits (10 percent).

With the annual increase in the employee contribution limit, a good message for plan participants is that “increasing your contribution rate, even by 1 percent, can make a big difference in your long-term retirement savings,” Barry said. “What may seem like a small amount today can have a significant impact on your account balance in 10 or 20 years.”

COMPLYING WITH CONTRIBUTION LIMITS

IRS records show that the vast majority of employees comply with annual limits on the amount of compensation that they can contribute to their 401(k) plans, according to a 2018 report by the Treasury Inspector General for Tax Administration. Nonetheless, the inspector general identified two areas in which compliance could be improved:

Some 401(k) plans did not prevent taxpayers from exceeding the annual limit.

Some employees exceed annual limits when contributing to multiple 401(k) plans.

The findings suggest that employers ensure that their payroll systems don’t accept participant contributions that exceed the annual dollar limit, and that employers educate plan participants who may be holding more than one job that the annual limit applies to total contributions to all 401(k) plans.

401(k) After-Tax Contributions

A Roth 401(k) is funded with after-tax dollars and withdrawals are tax-free during retirement, while a traditional 401(k) is funded with pretax dollars and withdrawals are taxed as income during retirement.

Many plans allow participants to convert dollars in a traditional 401(k) account to the plan’s Roth account, although the participant must then pay income taxes on all dollars (pretax contributions and earnings) being converted. When withdrawn from the Roth account during retirement, no taxes are subsequently owed.

Some plans, however, will also allow employees to make additional after-tax—but non-Roth—contributions to a traditional 401(k) once the 2023 participant contribution limit of $25,500 (or $30,000 after age 50) is exceeded, up to the “all sources” employer-plus-employee contribution limit of $66,000 (or $73,500 after age 50).

If the plan document allows after-tax contributions to traditional 401(k) accounts, then by following the correct steps employees can convert these contributions to Roth dollars within the plan, or to a Roth individual retirement account (IRA), so that the after-tax traditional 401(k) contributions become, effectively, Roth contributions. At the time of the conversion, only earnings are taxed as income, while the dollar amount of the after-tax plan contributions will covert tax free.

[SHRM members-only Toolkit: Designing and Administering Defined Contribution Retirement Plans]

Defined Benefit Plan Limits

Sponsors of defined benefit pension plans should note that the IRS announced the following COLAs under tax code Section 415, also taking effect on Jan. 1:

Annual benefit limit. The maximum annual benefit that may be provided through a defined benefit plan is increased to $265,000 from $245,000.

Separation from service. For a participant who separated from service before Jan. 1, 2023, the annual benefit limit for defined benefit plans is computed by multiplying the participant’s compensation limit, as adjusted through 2022, by 1.0833. This is an increase from the previous year, when the participant’s compensation limit, as adjusted through 2021, was multiplied by 1.0534.

Separately, the federal Pension Benefit Guaranty Corp., which insures private-sector defined benefit pension plans, posted 2023 premium rates for single-employer and multiemployer pension plans.

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For 2023, 401(k) Contribution Limit Rises to $22,500 with $7,500 ‘Catch-Up’

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