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Comparison of 2023 401(k) and IRA Contribution Limits

Triston Martin

Jan 02, 2024

While 401(k) contributions are made with pre-tax earnings, those to a Roth IRA are made with after-tax dollars. When you cash out, you will get your original investment plus any interest earned.

In addition, 401(k)s are set up by companies and funded solely by salary deferrals (i.e., deductions from paychecks). At the same time, individuals contribute to Roth IRAs and are not limited by either income or contribution caps.

401(k) Contribution Limits

If you minimize your taxable income by contributing to a retirement plan through your company, such as a 401(k) or 403(b), you will pay less in taxes overall. These discretionary contributions can be, at most, $22,500 in 2023—the catch-up contribution limit for workers aged 50 and up is $7,500. Equal or partial matching of retirement funds is common practice among many workplaces. You cannot contribute more than $66,000 or $73,500 if you are above 50 and your employer offers a matching contribution.

How to Invest in Either Account

The two accounts have substantially different investment options: Payroll deductions are used for 401(k) contributions, whereas checks or electronic funds transfers can be used for Roth IRA contributions.

Withdrawals from a Roth IRA are subject to no penalties or taxes, though you will still owe income taxes on the money. However, you must pay taxes and penalties if you cash out your 401(k) before retirement.

What to Do If You Invest Excessively in an IRA or 401(k)

You may have to pay more taxes if you contribute less to your 401(k) or individual retirement account. Taxes on excess contributions and earnings (interest, etc.) are assessed at a rate of 6% per year for as long as the funds remain in the retirement account. The maximum annual tax that can be deducted from your IRAs is 6%.

Ways to Keep Your Excess Donations Tax-Free

Excess contributions and earnings on those contributions can be withdrawn before the individual tax return deadline to avoid the 6% tax. The date is April 18, 2023, for donations made in 2022. If you want this money by the April 18 deadline, you should make your request a month in advance.

Contact your 401(k) plan's administrator to request a corrected distribution of your excess contributions and any interest or growth they have accrued. An updated W-2 should be issued to reflect the inclusion of the distributed monies in your annual salary. The same procedure should be followed with your financial institution if you over-contributed to an IRA. If you made a profit on your overage donation, you should receive Form 1099-R to report the amount earned.

What if You Miss the Due Date

There is a 6% tax on excess contributions if they are not withdrawn by the tax filing date. Since the 6% tax is applied annually for as long as the funds remain in the account, you will end up forking over cash not once but twice: once for the previous year and once for this one. If you want to avoid paying an extra 6% when the new year rolls around, make the rectification withdrawal as soon as feasible.

Traditional IRAs and Roth IRAs are two additional vehicles for retirement planning. In 2023, the maximum amount you can put into a regular or Roth IRA is $6,500, up $500 from the previous year. If you earn $3,500 in 2022, the most you may put into your IRA that year is also $3,500.

If both members of a married filing jointly couple earn more than the maximum IRA contribution amount, then each member can make the maximum IRA contribution.

Both conventional and Roth IRA contributions count against your annual IRA contribution maximum. You can divide your donation between these two options but not put more than $6,500 into any account.

Roth vs. 401(k): What to Think About

Current Income Status

If your income is below $107,000 (joint filers) or $72,000 (single), you may qualify for a Roth IRA.

However, if your yearly salary is more than $17,500 (or $23,000 if you are age 50 or older), you may want to consider a 401(k) rather than a Roth IRA due to the taxation of contributions upon withdrawal and the contribution limits of each.

When Do You Anticipate Spending The Cash?

Choose a Roth IRA if you plan to remove your money from the account within the next five years, as you will not be subject to taxes on the earnings.

On the other hand, if you are in a high tax bracket today but anticipate being in a lower one in retirement, it makes sense to keep your money in a 401(k) and take advantage of the tax deduction.

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