A guide to 401(k)s and 401(k) contributions: Yearly limits and ideal rates

Many employers offer 401(k)s as part of their employment benefits. By enrolling in your employer's plan, you can save and grow your money over time to eventually have enough to fund your retirement. There are some provisions and restrictions, however, so it's helpful to learn how 401(k)s work and what you can and cannot do over the life of your account. The following guide can help you understand the ins and outs of 401(k)s and 401(k) contributions.

What is a 401(k)?

A 401(k) is an employer-sponsored retirement plan, available to people who work for companies that offer it. The general idea behind the 401(k) is that you automatically contribute a percentage of your regular paycheck into this retirement account, and select a portfolio of underlying investments. Over time, the combination of an increasing account balance and asset appreciation allows your money to grow tax-deferred. Ideally, by the time you retire, your 401(k) will have grown large enough to help you realize your retirement goals.

Your plan may include a 401(k) match, an incentive by which your employer contributes up to a certain percentage relative to your contributions to your account. For example, imagine you work for a company that offers a dollar-for-dollar 401(k) match of 4%. If you put 1% to 4% of your regular pay into your account, your employer will match the entire amount. If you put in 8%, however, the employer will match only the first 4%.

Even if you leave your job, your 401(k) remains in your name. Depending on your situation, you can keep your account open with your previous employer, roll the funds over into a different retirement account (including your current employer's plan), or completely cash it out (bearing in mind the 10% penalty for withdrawals before the age of 59½). If your account balance is under $1,000, your employer can automatically cash you out and cut you a check, minus tax deductions.

You can withdraw money from your 401(k) account at any time, but you owe a 10% penalty tax if you make withdrawals before the age of 59½ (there are exceptions, however). 

Types of 401(k) plans

As an employee, you're likely to encounter one of the following two types of 401(k) plans:

• Traditional: With a traditional 401(k), you fund your account with pre-tax dollars. When you begin receiving distributions, you'll owe ordinary income tax on your withdrawals.
• Roth: A Roth 401(k) is funded with post-tax dollars, meaning that your contribution rate is determined after federal and state tax deductions. As a result, the account holder normally doesn't pay taxes on their earnings or distributions down the road.

Benefits of a 401(k)

Aside from the fact that you're automatically putting away a percentage of every paycheck and establishing a habit of hands-off saving, participating in a 401(k) plan has the following benefits:

• Tax advantages: A traditional 401(k) allows you to minimize your present tax burden while your contributions grow tax-deferred, and your later withdrawals will be taxed as ordinary income during a time when you're likely to be in a lower tax bracket. With a Roth 401(k), your distributions are generally untaxed.
• Growth: A 401(k) isn't just a savings account. Your contributions can grow exponentially depending on how your chosen investments perform.
• Portability: You don't have to worry about losing your 401(k) benefits if you leave your job, as the account will remain in your name unless you receive a check for the account's balance.

How much can you contribute to your 401(k)?

The Internal Revenue Service (IRS) sets contribution limits that cap the amount of money you can deposit into your 401(k) each year. These limits are in place to prevent higher-earning employees from realizing a disproportionate advantage from their tax-sheltered contributions compared to others.

The IRS regularly adjusts the yearly contribution limit to account for inflation. In 2024, the contribution limit for both traditional and Roth 401(k)s is $23,000 per individual — $500 more than in the previous year. If your employer offers a 401(k) match, your combined limit for 2024 is $69,000 — $3,000 more than in 2023.

Contribution limits restrict funding maximums per individual, not per plan. If you work for multiple employers that all offer 401(k) plans, your total contribution limit is the aggregate of all your accounts. So, if you have one 401(k) account with contributions of $12,000 and another with $11,000 in contributions, you've already met your limit for the year.

"The Internal Revenue Service (IRS) sets contribution limits that cap the amount of money you can deposit into your 401(k) per year. These limits are in place to prevent higher-earning employees from realizing a disproportionate advantage from their tax-sheltered contributions compared to others."

What if you exceed your 401(k) contribution limit?

If you over-contribute to your 401(k) for the year, the excess contribution amount is subject to double taxation — once in the year of contribution and again at the time of withdrawal. 

If you do contribute too much to your 401(k), immediately contact your employer or plan administrator. Tell them you've made an excess deferral, and specify the amount you've over-contributed. You can receive a corrective distribution or a return of your money that equals the surplus amount. The distribution must be paid to you by April 15 to avoid penalties.

The corrective distribution will increase your taxable income for the year, so your employer should also provide you with an amended W-2. That's the document you'll use when you file your taxes for the year. If your excess contribution realizes any earnings, that income will also be reflected in your tax bill, in which case your employer or plan administrator should provide you with a Form 1099-R.

What are catch-up contributions?

Catch-up contributions are optional deferrals that allow employees aged 50 or older to contribute more than the annual contribution limit. This helps those who are nearing retirement reach their savings goals. Essentially, catch-up contributions enable pre-retirees to make up for those years, earlier in their careers, when they couldn't contribute enough money to their 401(k) accounts.

In 2024, the catch-up limit for 401(k)s is $7,500 higher than the standard contribution limit. That means that an individual can fund their account up to $30,500 per year as long as they're at least 50 years old.

What's a good 401(k) contribution rate?

What qualifies as a good 401(k) contribution rate depends on variables such as age, salary, expenses, retirement goals, and current savings. Many financial advisers recommend contributing at least 10% to 20% of your regular paycheck for the best odds of growing your investments enough to fund your retirement. If you earn $65,000 per year, for example, a 10% contribution would amount to $6,500 per year, and a 5% employer match would increase the total contribution to $9,750. At that rate, your account could grow to over $1.6 million over 40 years. 

The general rule is to contribute as much as you can. To determine the exact contribution rate that will suit your needs, calculate your fixed and monthly expenses, and then subtract them from your earnings. Any portion of what remains can be put toward your 401(k), though you may want to hold some back in case of emergencies.

If you want to participate in a 401(k) plan, but your current employer doesn't offer one, take advantage of CareerBuilder's resources to find a job that does. Get email alerts so you can find positions that match your preferences without having to search actively online, and narrow your options based on the benefits offered.

More tips about saving money for retirement

A part-time job can go a long way toward supporting your lifestyle either before your retirement or during semi-retirement. In either case, you may want to know what part-time jobs pay well.

Your current employer may allow you to stay with the company in semi-retirement by reducing your hours to a part-time position.

An alternative option in retirement is to participate in the gig economy. There are plenty of low-stress roles you might consider.