Investing Retirement Planning 401(k) Plans How Do Tax Reforms for 401(k) Plans Affect You? Understand How 401(k) Plan Changes Could Affect Your Retirement By Scott Spann Scott Spann Facebook Twitter Website Scott Spann is an investing and retirement expert for The Balance. He is a certified financial planner with over two decades experience. Scott currently is senior director of financial education at BrightPlan. Scott is also a published author and an adjunct professor at Maryville University, where he teaches personal finance. learn about our editorial policies Updated on March 18, 2022 Reviewed by Thomas J. Brock Reviewed by Thomas J. Brock Thomas J. 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Her stint as a legal assistant at a law firm equipped her to track down legal, policy and financial information. learn about our editorial policies In This Article View All In This Article Understanding 401(k)s Contribution Limits Before Age 50 Limits for Workers 50 and Older Employer Matching Limits Highly Compensated Employees Income Tax Brackets The Bottom Line Photo: SrdjianPav / Getty Images Employer-sponsored 401(k) plans have long been popular with investors, because of the tax benefits they provide. While these accounts have been available since 1978, tax reforms have resulted in changes to IRS regulations regarding 401(k) accounts, mostly involving contribution limits. Staying on top of ongoing changes in 401(k) rules can help you maximize your plan contributions. Key Takeaways 401(k) contributions are tax-deductible and tax-deferred, so you pay no taxes on contributions or gains until you withdraw the money.Tax rules limit how much employers and employees can contribute, with the amount being higher for workers age 50 than for those under 50.The average contribution for those who qualify as highly compensated employees can be no more than 2% greater than for those who are not HCEs.Tax reforms can change federal income tax brackets, tax rates, and income ranges, which can affect the tax deduction you get for 401(k) contributions. Understanding 401(k)s One of the most popular options for employer-sponsored retirement savings plans is the 401(k) plan. Traditional 401(k) contributions are tax-deductible, which means they reduce your taxable income and can lower your tax bill. They are also tax-deferred, which means you make them on a pre-tax basis. You pay no taxes on the contributions you make to the account—or on the gains you made on the investments—until you withdraw the money. Thus far, these two key features of 401(k) plans have not been subject to changes despite various tax reforms, which has been a boon to savers. Earners often will be in a lower tax bracket in retirement when they are withdrawing their 401(k) funds than they are at the time of contribution, meaning that they'll pay taxes on their withdrawals at a lower rate. There are penalties for early withdrawal, however. If you take money from the account before you reach age 59 1/2, the IRS will charge a 10% penalty plus income taxes on the withdrawal. Contribution Limits Before Age 50 The IRS often changes the limits on how much employees under the age of 50 may contribute to their 401(k) accounts. The contribution limit for persons under age 50 for tax year 2021 is $19,500 (unchanged from 2020). In 2022, this limit increases to $20,500. Increases to these limits are made for cost-of-living adjustments that are tied to the Consumer Price Index (CPI). The CPI measures inflation and rises only in $500 increments, which is why there isn't an increase every year. If the CPI doesn't go up enough to warrant a $500 increase, there will be no change in the contribution limit. That is why the limit did not change from 2020 to 2021, for example. Note These 401(k) rules do not impact an investor's ability to contribute to a different plan, such as a Roth IRA. Roth IRAs can be opened by any qualifying individual who does not earn more than the maximum income levels, which are $140,000 or more for individuals and $208,000 or more for married couples filing jointly. In 2022, these limits increase to $144,000 for individuals and $214,000 for married couples. Contribution Limits for Workers Age 50 and Older The IRS allows for catch-up provisions that enable older workers to contribute even more to their accounts. This 401(k) allowance helps those who might not have contributed as much when they were younger to grow their account before they retire. Like the standard contribution limit, the limit for catch-up contributions increases most years according to tax reforms governing 401(k) plans. For tax years 2021 and 2022, the catch-up amount is $6,500. This additional amount increases the total 401(k) contribution limit for workers age 50 and older to $27,000. Employer Matching Limits Some employers make an additional contribution to a 401(k) that matches the amount their employees contribute, up to a certain percentage or dollar limit. The match varies from employer to employer and also applies to those who are self-employed. A self-employed individual can contribute to their own account as both an employee and an employer. For the 2021 tax year, the limit for combined contributions from employee and employer is $58,000; this increases to $61,000 for 2022. That does not include any funds contributed under the catch-up provision; the combined employee-employer limit for employees older than age 50 is $64,500 in 2021 and $67,500 in 2022. Highly Compensated Employees (HCEs) Contribution limits get more complex for workers who are labeled HCEs by the IRS. When 401(k)s were established, a rule was put in place to limit the disparity between how much a firm's highest-paid employees could contribute, compared to its lowest-paid employees. As a result, at any individual company, the average amount of the contributions for those who qualify as HCEs can be no more than 2% greater than the average amount of contributions for those who are not HCEs. The yearly income that constitutes "highly compensated" is subject to cost-of-living adjustments and therefore changes over time. For the tax years 2021 and 2020, an HCE is someone who made more than $130,000. This limit increases to $135,000 in 2022. Individuals are also considered HCEs if they own more than 5% of the business at any time during the tax year in question. Implications for HCEs vary from employer to employer. If the average contribution amount for non-HCEs at a particular firm is 5% of their income, the average contribution amount for all HCEs at the firm can generally be no more than 7%. Every year, 401(k) plans must run nondiscrimination tests to make sure everyone is in compliance. If you think you might qualify as an HCE, check with your employer's human resources department for guidance on how much to contribute. Income Tax Brackets Tax reform can also cause changes in the federal income tax brackets, which are income ranges that are subject to taxes at different rates. For 2021, there are seven brackets ranging from 10% to a top rate of 37%. Dramatic changes in the income tax brackets don't occur often, and when they do, they don't directly impact your 401(k) contribution limits. However, changes to the tax rates or income ranges can affect the tax deduction you get when you make 401(k) contributions, since your contributions reduce your taxable income. For example, as a result of the Tax Cuts and Jobs Act, the top income tax bracket is 37% for tax years 2021, 2020, 2019, and 2018, down from 39.6% in 2017. If you made a 401(k) contribution of $10,000 that was taxed at a rate of 25% in 2017, you would have saved $2,500 in taxes. If that same $10,000 was taxed at only 22% in 2018, you would have saved only $2,200, or $300 less. The Bottom Line Reforms are continually made to the tax code, and when they impact IRS regulations governing 401(k) plans, they also impact your contribution limits and deduction potential. Keeping tabs on ongoing changes to 401(k) plan rules can set you up for increased savings, a larger nest egg, and a more comfortable retirement. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. The Urban Institute. "Do Low-Income Workers Benefit From 401(K) Plans?," Page 3. Internal Revenue Service. "401(k) Plan Overview." Internal Revenue Service. "Retirement Topics - Exceptions to Tax on Early Distributions." Internal Revenue Service. "Income Ranges for Determining IRA Eligibility Change for 2021." Internal Revenue Service. "2022 Limitations Adjusted as Provided in Section 415(d), etc.," Page 1. Internal Revenue Service. "Chapter 8a Selected Topics Under Irc Section 415(C), Section 415(B), and Section 415(E), as Amended by Gatt, Sbjpa, and the Taxpayer Relief Act of 1997," Page 21. Internal Revenue Service. "COLA Increases for Dollar Limitations on Benefits and Contributions." Internal Revenue Service. 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