Annual Compensation Limit

The annual compensation that is used to determine a participant’s allocation of employer contributions, as well as their own deferrals or voluntary after-tax contributions, may not exceed the Annual Compensation Limit in effect for each plan year. This value is an annually adjusted dollar amount specified in IRC Sec. 401(a)(17).

For 2020, the dollar amount is $285,000. For example, if you earn $1,000,000 in 2020 and your company’s 401(k) plan provides a match of 100% of employee deferrals up to a maximum of 5% of compensation, the company matching contributions will be capped at  $14,250 (5% x $285,000), rather than $50,000 (5% x $1,000,000). The remaining $715,000 of your 2020 compensation is not taken into account for any purpose under the plan.

All employer contributions for any single year must be determined by taking into account only the amount of a participant’s compensation up to the compensation limit for that year.  Examples include:

Similarly, where applicable in performing the nondiscrimination testing for a single year, each participant’s compensation must be capped at the compensation limit. This includes both ADP and ACP tests. For example, only compensation up to the dollar amount for that year will be applied in performing these tests.

Short Plan Years

For new plans with short plan years (that begin from 3/1-12/1), the annual compensation limit must be prorated by the number of full months of the short plan year. For example, if the first plan year started on July 1, 2019 - December 31, 2019, the annual compensation limit for that short year is $142,500.

 

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