Elective-Deferral Contribution

What it is

An elective-deferral contribution is a portion of an employee’s salary that the employee elects to have withheld and deposited into an employer-sponsored retirement plan (for example, a 401(k) or 403(b)). These contributions can be made on a pre-tax (traditional) or after-tax (Roth) basis depending on the plan.

Key points

• Pre-tax contributions reduce current taxable income; taxes are paid on withdrawals in retirement.
• Roth contributions are made with after-tax dollars; qualified withdrawals are generally tax-free.
• The IRS sets annual contribution limits that apply across all accounts of the same type.
• Employer matching and other employer contributions are subject to a separate, higher combined limit.

How elective deferrals work

Employees authorize payroll withholding to send part of each paycheck directly to their retirement account. For example, deferring $100 per month from a $40,000 salary lowers taxable pay by $1,200 for that year (taxable income becomes $38,800).

Withdrawals from pre-tax accounts are taxed as ordinary income when distributed. Withdrawals taken before age 59½ may be subject to a 10% early-distribution penalty unless an exception applies; state or local taxes may also apply. Roth accounts offer a different tax treatment for qualified distributions.

If an employee has multiple plans (traditional and Roth or plans at different employers), the annual elective-deferral limit applies in the aggregate.

Contribution limits (IRS)

2024 limits:
* Employee elective-deferral limit (under age 50): $23,000
* Catch-up contribution (age 50 and over): additional $7,500 → total $30,500
* Total contributions from all sources (employee + employer + other contributions): limited to the lesser of 100% of compensation or:
* $69,000 for participants under 50
* $76,500 for participants 50+ (includes catch-up)

2023 limits:
* Employee elective-deferral limit (under age 50): $22,500
* Catch-up contribution (age 50 and over): additional $7,500 → total $30,000
* Total contributions from all sources: lesser of 100% of compensation or:
* $66,000 for participants under 50
* $73,500 for participants 50+ (includes catch-up)

If you exceed the elective-deferral limit, you must correct the excess contribution to avoid penalties.

Tax treatment

• Traditional (pre-tax) elective deferrals: reduce current taxable income; taxable when distributed.
• Roth (after-tax) elective deferrals: no upfront tax benefit; qualified withdrawals are generally tax-free.
• You do not claim a separate tax deduction for 401(k) contributions on your tax return—the benefit is that pre-tax contributions lower taxable wages reported for the year.

FDIC insurance

Most 401(k) assets are investments (mutual funds, stocks, bonds) and are not FDIC insured. Some plans offer bank deposit options that may be FDIC insured if the plan lets participants place money in eligible deposit accounts.

Bottom line

Elective deferrals are a primary way to build retirement savings and can lower current taxes when made on a pre-tax basis. Take advantage of employer matching if available, stay within IRS limits (which apply across plans), and understand the tax and withdrawal rules for traditional versus Roth contributions.

Sources: Internal Revenue Service; Federal Deposit Insurance Corporation