Contributions

How Retirement Contributions Work in 401(k)s and Other Plans

Retirement contributions are deposits made by employees and employers into qualified retirement plans like 401(k)s, 403(b)s, and IRAs. Understanding how employee contributions, employer matching contributions, and contribution limits work is essential for maximizing your retirement savings and tax benefits.

In retirement planning, contributions are the money you and your employer put into retirement accounts like 401(k)s and IRAs. These regular deposits, combined with investment growth over time, form the foundation of your retirement savings.

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Key Takeaways

- Employee contributions to qualified retirement plans like 401(k)s are limited to $23,500 in 2025, with additional catch-up contributions available for those age 50 and older 

- Employer matching contributions don't count toward employee contribution limits and can significantly boost retirement savings 

- Safe harbor contributions help employers meet IRS nondiscrimination requirements and must be immediately vested 

- Traditional vs Roth contributions offer different tax treatment; traditional contributions reduce current taxable income while Roth contributions provide tax-free withdrawals in retirement 

- Contribution limits vary by account type, with 401(k)s allowing $23,500, IRAs allowing $7,000, and Solo 401(k)s allowing up to $70,000+ for self-employed individuals in 2025 

- Rollovers don't count as contributions and won't affect your annual contribution limits 

- Vesting schedules determine when you own employer contributions, while your own contributions are always 100% yours immediately

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What Are Contributions in Retirement Plans?

In simple terms, a contribution is the money added to a retirement account. These deposits may come from the employee (called employee contributions) or from the employer (employer contributions). Together, they form the core of most people's retirement savings in what is known as a defined contribution plan.

A defined contribution plan includes accounts like 401(k)s, 403(b)s, and IRAs, where the eventual retirement benefit depends on how much you and your employer contribute, plus investment growth. This is different from a defined benefit plan which promises a fixed payout at retirement rather than being dependent on contributions and investment performance.

Defined Benefit vs Defined Contribution Plans

Understanding the difference between these two plan types helps clarify how retirement contributions work:

- Defined contribution plans (401(k), 403(b), IRA): Your retirement benefit depends on total contributions made and investment performance. You bear the investment risk, but you also control contribution amounts and investment choices. These plans are portable, meaning you can take them with you when changing jobs.

- Defined benefit plans (traditional pensions): Your employer promises a specific monthly payment in retirement, typically based on salary and years of service. The employer bears investment risk and funds the plan. These plans are less portable and increasingly rare in the private sector.

How Do Retirement Contributions Work?

When you contribute to a retirement plan, your money is typically used to buy investments such as stocks, bonds or mutual funds. In most 401(k) or 403(b) plans, you can choose from a menu of funds offered by your employer, often including stock index funds, bond funds, or target-date funds. With IRAs or individual 401(k)s, you usually have broader flexibility to pick your own investments.

You might choose investments based on your time horizon and risk tolerance. For example, younger savers often lean more heavily toward stocks for growth, while those closer to retirement may allocate more to bonds for stability.

Taxpayers can choose to put money into a variety of different retirement accounts but are limited as to how much they can set aside each year. The amount you add each year is known as your annual contribution or elective deferral, and the IRS sets contribution limits to control how much money can receive tax advantages.

Many employers now automatically enroll employees at 3-6% contribution rates with annual increases through automatic escalation features. You can opt out or change this percentage at any time.

Types of Retirement Contribution Accounts

• 401(k) plans: Employer-sponsored accounts with pre-tax or Roth options; often include an employer match.
• 403(b) plans: Similar to 401(k)s but offered by public schools and nonprofits.
• IRAs (Individual Retirement Accounts): Available outside the workplace; can be Traditional (tax-deductible) or Roth (tax-free growth).
• 401(a) plans: Employer-controlled plans, often for government or nonprofit employees; contributions may be mandatory.
• Solo or Individual 401(k)s: For self-employed individuals; allow higher contribution limits.
• SIMPLE IRA plans: For small businesses with 100 or fewer employees; simpler administration with lower contribution limits than 401(k)s.
• Cash balance plans: A type of defined benefit plan that combines features of pensions with contribution-based funding.

While contributions usually refer to retirement accounts, the term can also apply to investment accounts outside of retirement, such as HSAs, 529 plans, or taxable brokerage accounts. The difference is that only qualified retirement accounts have IRS-defined contribution rules and limits.

401(k) Contributions Explained

Employee Contributions and Elective Deferrals

A 401(k) is the most common type of defined contribution plan. Employees can decide how much of their paycheck to set aside, up to annual IRS limits. These deposits are called employee contributions or elective deferrals.

Traditional vs Roth 401(k) Contributions

Contributions can be made pre-tax (traditional 401(k)) or after-tax (Roth 401(k)). Pre-tax contributions lower your adjusted gross income (AGI) which may reduce your tax bill. Roth 401(k) contributions don't provide an immediate tax deduction, but qualified withdrawals in retirement are tax-free. The choice between traditional and Roth often depends on your expected tax bracket in retirement. Consider consulting a tax professional to evaluate your specific situation.

2025 Contribution Limits and Catch-Up Contributions

In 2025, employees can contribute up to $23,500 to a 401(k).

Additional catch-up contributions are available based on your age:

• Age 50-59 or 64+: Additional $7,500 catch-up contribution
• Age 60-63: Enhanced catch-up contribution of $11,250 (new under SECURE 2.0 Act)
• Under age 50: Standard $23,500 limit only

How 401(k) Contributions Affect Social Security Benefits

401(k) contributions reduce your current-year W-2 wages for Social Security tax purposes, which means you pay less Social Security tax on that income. However, this could theoretically affect your future Social Security benefits if you're in one of your highest 35 earning years, since benefits are calculated based on your 35 highest-earning years. For most people, the impact is minimal and the tax benefits of 401(k) contributions outweigh this consideration.

Contributing Bonuses to Your 401(k)

Bonuses can also be contributed to a 401(k), as long as total contributions stay under the annual limit.

Important: 401(k) contributions must be made by December 31st for that tax year. If you change jobs mid-year, track your contributions across both employers to avoid exceeding the annual limit. Over-contributions are taxed twice, once when earned and again when withdrawn.

Employer Contributions and Matching Programs

Many employers help employees save through employer contributions. The most common form is an employer match, where the company contributes a set percentage of your salary based on how much you contribute. For example, a 50% match up to 6% means if you contribute 6%, your employer adds 3%.

Example: If you earn $60,000 annually and contribute 10% ($6,000) with a 50% employer match up to 6% of salary, you'd get an additional $1,800 in employer money, totaling $7,800 in annual retirement contributions.

Understanding Employer Match Programs

An employer match is a contribution your employer makes to your retirement account based on your own contributions. Common matching formulas include:

- Dollar-for-dollar match: Employer matches 100% of your contributions up to a certain percentage (e.g., 100% match on first 3% of salary) 

- Partial match: Employer matches a portion of your contributions (e.g., 50% match on first 6% of salary) 

- Tiered match: Employer uses different match rates for different contribution levels (e.g., 100% on first 3%, then 50% on next 2%)

Many financial experts consider maximizing employer matching contributions a fundamental retirement savings strategy, as employer matches represent additional compensation that can significantly boost retirement savings over time. However, individual circumstances vary, and what works best depends on your specific financial situation.

Safe Harbor Contributions

Safe harbor contributions are specific types of employer contributions that help 401(k) plans automatically pass IRS nondiscrimination testing. These tests ensure that highly compensated employees don't benefit disproportionately from the plan compared to other employees.

Common safe harbor contribution formulas include: 

- Basic safe harbor match: 100% match on the first 3% of compensation, plus 50% match on the next 2% (total of 4% employer contribution if employee contributes 5% or more) 

- Enhanced safe harbor match: 100% match on the first 4% of compensation 

- Non-elective safe harbor contribution: 3% of compensation to all eligible employees, regardless of whether they contribute

Safe harbor contributions must be 100% vested immediately, meaning employees own them right away without waiting periods.

Common Employer Contribution Questions

Are Companies Required to Match? No. Employer matching is optional, but employers often offer it to stay competitive and to encourage employee participation. Employers also receive tax benefits for making contributions.

Do Employer Contributions Affect the 401(k) Limit? Employer deposits do not count toward the employee's annual limit, but there is a total cap on combined contributions of $70,000 for those under 50, $77,500 for ages 50-59 and 64+, and $81,250 for ages 60-63 (inclusive of catch-up contributions).

Can an Employer Contribute to a 401(k) Without Employee Contributions? Yes, some employers will choose to make non-elective contributions regardless of whether the employee participates.

Are Employer Match Contributions Pre-Tax? Yes. Employer contributions are pre-tax and will be taxed as ordinary income when withdrawn in retirement.

Understanding Vesting Schedules

While your own contributions are always 100% yours immediately, employer contributions may be subject to vesting schedules, meaning you might need to stay with the company for a certain period (typically 2-6 years) to keep all employer contributions if you leave. If you leave before being fully vested, you may forfeit some or all unvested employer contributions.

Common vesting schedules include: 

- Immediate vesting: 100% vested from day one (required for safe harbor contributions) 

- Cliff vesting: 0% vested until a specific date, then 100% (e.g., 100% after 3 years) 

- Graded vesting: Gradual vesting over time (e.g., 20% per year over 5 years)

Other Retirement Account Contribution Limits and Rules

403(b) Plans

For schools and nonprofits. Employees can contribute up to $23,500 in 2025, plus $7,500 catch-up if age 50-59 or 64+, or $11,250 if age 60-63.

401(a) Plans

Employer-controlled, often mandatory. Combined employee + employer contributions are capped at $70,000 for those under 50, or up to $81,250 with applicable catch-up contributions in 2025.

IRAs (Traditional and Roth)

Individual accounts outside the workplace. Annual limit is $7,000, or $8,000 if age 50+ ($1,000 catch-up). IRA contributions can be made until the tax filing deadline (typically April 15th of the following year), unlike 401(k) contributions which must be made by December 31st. Lower annual limits but more investment flexibility.

Solo 401(k) Plans for Self-Employed

For the self-employed. As the employee, you can contribute up to $23,500 (plus applicable catch-up). As the employer, you can contribute up to 25% of your W-2 wages if you operate as an S-corporation, or up to 20% of net self-employment income if you operate as a sole proprietor or single-member LLC. Combined, total contributions (employee + employer) can reach $70,000 in 2025, or up to $81,250 with catch-up contributions depending on your age. You can contribute as both the employer and employee.

SIMPLE IRA Plans

For small businesses with 100 or fewer employees. Employee contribution limit is $16,500 in 2025, with a $3,500 catch-up contribution for those age 50+. Employers must either match employee contributions dollar-for-dollar up to 3% of compensation, or make a 2% non-elective contribution for all eligible employees.

Compensation Limits

The IRS also limits the amount of compensation that can be considered when calculating retirement contributions. For 2025, this limit is $345,000. This means that even if you earn more, contribution calculations are based on a maximum of $345,000 in compensation.

Advanced Contribution Strategies

Mega Backdoor Roth Strategy for High Earners

If you've maxed out regular 401(k) contributions and your plan allows after-tax contributions, you may be able to contribute additional money beyond the $23,500 limit and convert it to Roth through a mega backdoor Roth strategy. This advanced technique allows high earners to potentially contribute tens of thousands more in after-tax dollars, then convert them to Roth (either through in-plan Roth conversion or rollover to a Roth IRA) to benefit from tax-free growth. This strategy has specific requirements and tax implications, so consider consulting with a tax professional before implementing it.

Retirement Savings Contributions Credit (Saver's Credit)

Lower and moderate-income taxpayers may qualify for the Retirement Savings Contributions Credit, also known as the Saver's Credit. This tax credit can be worth up to $1,000 ($2,000 for married couples filing jointly) and is available to eligible taxpayers who make contributions to qualified retirement plans. Income limits apply and are adjusted annually.

Required Minimum Distributions (RMDs)

Once you reach age 73 (or 75 if you were born in 1960 or later), you must begin taking Required Minimum Distributions (RMDs) from Traditional 401(k)s, Traditional IRAs, and other tax-deferred accounts. Roth IRAs are not subject to RMDs during your lifetime. RMDs force taxable withdrawals whether you need the money or not, which is an important consideration in your contribution and withdrawal strategy as you approach retirement. Failing to take RMDs results in a steep penalty of 50% of the amount you should have withdrawn (reduced to 25% under SECURE 2.0, and potentially 10% if corrected promptly).

Job Changes and Rollovers

When changing jobs, you can typically roll over your 401(k) to your new employer's plan or to an IRA, maintaining the tax-advantaged status of your contributions. This allows your money to continue growing tax-deferred. Be sure to coordinate the timing to avoid having funds sent to you directly, which could trigger taxes and penalties.

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