Small business owners often want to start a 401(k) plan to attract and retain talent, as well as to plan for their own retirement. If you run a small business, at some point you’ve probably found yourself weighing the pros and cons of starting a 401(k) plan. If so, you may be wondering, “How much can a business owner contribute to a 401(k)?”
The Internal Revenue Service (IRS) is responsible for setting 401(k) contribution limits. There are two annual limits that apply to contributions: a limit on employee elective deferrals and an overall limit on contributions to a participant’s plan. Last year, the IRS announced cost of living adjustments for the 2018 tax year. These changes impact owner 401(k) contribution limits and are important to understand before moving forward with starting a retirement plan. What are the rules and what’s changed? We’ll break it down for you.
1. Employee Contribution Limits For 401(k) Plans
The limit on employee elective deferrals, which includes both traditional and safe harbor 401(k) plans, is $18,500 in 2018. This number has increased from $18,000 as a cost-of-living adjustment, and may be adjusted again in future years.
2. Plan-based Restrictions On Elective Deferrals
There are also restrictions that may reduce the maximum number of allowable elective deferrals. For example, if you’re a business owner or a highly compensated employee, your plan may need to limit your number of allowable elective deferrals in accordance with nondiscrimination laws. The definition of a highly compensated employee is unchanged from last year, at $120,000.
3. Catch-up Contributions for Those 50 and Over
At the end of the calendar year, participants age 50 and over can also make catch-up contributions. For traditional and safe harbor 401(k) plans, up to $6,000 can be contributed in addition to the $18,500 limit. This number was not adjusted for the 2018 tax year. Note: You don’t need to be behind in your contributions to make additional elective deferrals to your plan. Keep in mind that the rules around catch-up contributions are complex, and limits may differ depending on the provisions in your specific plan.
4. Overall Limit On Total Contributions
There is also a limit to the total annual contributions that can be made to a plan. This limit includes:
- Elective deferrals
- Employer matching contributions
- Employer non-elective contributions
- Allocations of forfeitures
Annually, the aggregate of all contributions cannot exceed whichever is less: 100 percent of a participant’s compensation or $55,000, up from $54,000 in 2017. These totals do not include catch-up contributions; therefore, for participants age 50 or over, the annual total is $61,000.
So what happens if you do exceed the annual limit?
If you find you have an excess deferral, you have the opportunity to withdraw the excess funds from your plan by before taxes are due. If you wait until after tax day, the excess deferral left in the plan is taxed twice. This can also prevent the plan from being considered a qualified plan.
A 401(k) for small business owners with employees may or may not make sense, depending on the level of employee interest in participating. Before moving forward, survey your team to see who would like to participate in the plan to determine whether or not it’s a good idea for your group to invest in a retirement plan.
If you’re still struggling to determine whether or not a 401(k) plan makes sense for your business, we can help! At Genesis HR, we offer a variety of robust, multiple employer plans that can be customized to meet your company’s unique needs. Contact us today for a free discovery call to learn more about our 401(k) offering.