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Another possible explanation: Some of the percentage limits are just outdated rules.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.
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) tutorial.
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