Limiting 401(k) Contributions

My company sets a contribution limit based on a percentage of my income, which makes my limit lower than $15,000. Can my company do this?

I know that the 401(k) limit for people under age 50 this year is $15,000. I want to follow this limit, but my company sets a contribution limit based on a percentage of my income, which makes my limit lower than $15,000. Can my company do this?

The company can allow it, but it actually may be a mistake. The key is to ask your employer about the reason for the percentage limit.

The most common explanation is because of "nondiscrimination rules." By law, companies cannot have a situation where highly compensated employees (currently those earning more than $100,000) contribute a lot more to their 401(k)s than the rest of the employees. As a result, some employers set a percentage of income limit to prevent this situation.

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If this is the case, see if your employer can do anything to encourage more lower-income employees to contribute to the plan. The new tax law made it easier for companies to enroll employees automatically in their 401(k)s (with an opt-out option), which can satisfy the nondiscrimination rules without limiting employees' contributions, says Bob D. Scharin, editor of RIA's Practical Tax Strategies.

Another possible explanation: Some of the percentage limits are just outdated rules. Before 2001, the employee's 401(k) contribution plus the employer match could not be more than 25% of a worker's income, so some employers capped their employee contributions at 15% to make sure they fell within those limits, says Rick Meigs, president of the 401khelpcenter.com (opens in new tab).

But in 2001, that limit was increased from 25% to 100%. "For all purposes, the plan limit was no longer necessary, but many plans never removed them," says Meigs.

Employers aren't required to make a change, but it's worthwhile to ask. If that's the only reason for the limits, see if the plan documents could be updated to eliminate the cut-off.

For more information about making the most of your 401(k), see our Max Out Your 401(k) (opens in new tab) tutorial.

Kimberly Lankford
Contributing Editor, Kiplinger's Personal Finance

As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.