What is an elective‑deferral contribution?
An elective‑deferral contribution (also called a salary‑deferral or salary‑reduction contribution) is the portion of an employee’s pay that the employee chooses to have withheld from their paycheck and deposited directly into an employer‑sponsored retirement plan — most commonly a 401(k). The employee must authorize the deferral. Deferrals to traditional 401(k) accounts are generally made on a pre‑tax basis (reducing current taxable income); deferrals to a Roth 401(k) are made after tax (no up‑front tax benefit but qualified withdrawals are tax‑free). (Investopedia; IRS)
Key points at a glance
– Elective deferrals are employee‑chosen payroll contributions to plans such as 401(k), 403(b) and certain governmental 457(b) plans. (IRS)
– Traditional 401(k) deferrals reduce current taxable income; Roth 401(k) deferrals do not. (IRS)
– The IRS sets annual limits on elective deferrals and on the total contributions to a participant’s plan from all sources (employee + employer). (IRS)
– Most 401(k) investments are not FDIC‑insured; certain bank‑type investment options inside plans may be insured. (FDIC)
How elective‑deferral contributions work
– Enrollment and authorization: Employees enroll in their employer’s retirement plan and specify either a dollar amount or percentage of pay to defer each pay period. Employers implement the payroll withholding and deposit the money into the plan. (IRS)
– Traditional vs. Roth:
– Traditional elective deferrals are deposited pre‑tax and reduce your taxable wages in the contribution year; distributions later are taxed as ordinary income.
– Roth elective deferrals are made after tax; qualified distributions of contributions and earnings are tax‑free if rules (age 59½ + five‑year rule) are met. (IRS)
– Withdrawals and penalties: Withdrawals from traditional 401(k) accounts are generally taxable. Distributions before age 59½ may be subject to a 10% early‑withdrawal penalty unless an exception applies. Roth 401(k) distributions of earnings are subject to rules for being qualified tax‑free. (IRS)
IRS limits (selected 2023–2024 figures)
– Elective‑deferral (employee) limit:
– 2024: $23,000 for employees under 50.
– 2023: $22,500 for employees under 50.
– Catch‑up contributions (age 50+):
– 2024: additional $7,500 (total possible elective deferral $30,500).
– 2023: additional $7,500 (total possible elective deferral $30,000).
– Total contribution limit (employee + employer + other employer contributions):
– 2024: the lesser of 100% of compensation or $69,000 (or $76,500 including age‑50+ catch‑up).
– 2023: the lesser of 100% of compensation or $66,000 (or $73,500 including catch‑up). (IRS — 401(k) contribution limits and related guidance)
Important details and common situations
– Roth and traditional 401(k) deferrals share the same elective‑deferral limit. If you split contributions between Roth and traditional accounts, the combined amount cannot exceed the employee limit. (IRS)
– Multiple employers/plans: If you participate in more than one 401(k) (or similar plan), the employee elective‑deferral limit applies in aggregate across all plans. You must track total deferrals to avoid excess contributions. (IRS)
– Employer matches, nonelective contributions and forfeitures are not counted against the employee elective‑deferral limit, but they do count toward the total contribution limit described above. (IRS)
– Excess deferrals: If you accidentally contribute more than the elective‑deferral limit, follow your plan’s procedure for correcting excess contributions promptly. The IRS provides rules for corrective distributions — if not corrected properly, you may face additional tax consequences. (IRS — plan fix‑it guides)
Are elective deferrals tax‑deductible?
– You do not claim a separate tax deduction on your Form 1040 for pre‑tax 401(k) contributions. Instead, the deferrals reduce your taxable wage amount reported on your W‑2 and thus lower your taxable income for the year. For tax purposes, Roth 401(k) contributions do not reduce current taxable income. (IRS)
Are 401(k) plans FDIC‑insured?
– Generally, investments held in 401(k) plans (mutual funds, ETFs, employer stock, brokerage shares) are not FDIC‑insured. If your plan offers a bank deposit or separately identifiable bank account option and you direct funds there, those funds may be eligible for FDIC insurance depending on how the plan account is structured. Check plan documents or ask the plan administrator. (FDIC)
Practical steps — how to manage elective‑deferral contributions
1. Review your plan’s materials
– Obtain the Summary Plan Description (SPD) or enrollment packet from HR or the plan administrator to learn available investment options, Roth/traditional options, matching formula, and enrollment steps.
2. Decide traditional vs. Roth (or a mix)
– Traditional: lowers current taxable income; pay taxes at withdrawal.
– Roth: no current tax break; qualified withdrawals are tax‑free (good if you expect higher tax rates in retirement).
– Consider tax bracket, expected retirement income, and need for current tax relief.
3. Choose your contribution amount
– Pick either a percentage of pay or a dollar amount per pay period.
– Aim to at least contribute enough to get the full employer match (free money), if available.
– Keep IRS limits in mind — monitor aggregate deferrals if you have more than one plan.
4. Maximize employer match first
– Determine the match formula (e.g., 50% of the first 6% of pay) and contribute at least that percentage to capture the full match before increasing beyond it.
5. Track year‑to‑date deferrals across jobs/plans
– If you change jobs or have multiple plans, track cumulative elective deferrals to avoid excess contributions.
– If you approach the IRS limit, you can reduce or stop deferrals later in the year.
6. If you exceed the limit, act quickly
– Contact your plan administrator immediately and request corrective distribution of the excess (and related earnings) per plan procedures and IRS rules. Timely correction keeps you from incurring double taxation. (IRS)
7. Rebalance and re‑evaluate annually
– Each year, recheck contribution levels, allocation, and whether to increase deferrals — especially after pay raises, changes in tax law, or eligibility for catch‑up contributions (age 50+).
8. Understand withdrawal rules and portability
– Learn hardship withdrawal rules, loans (if permitted), penalties for early withdrawals, and rules for rollovers (e.g., to an IRA) when you leave your employer. Make an informed decision when taking distributions. (IRS)
Examples
– Pre‑tax example: If you earn $40,000 and elect $100/month into a traditional 401(k), then $1,200 will be contributed that year and your taxable wages will be reduced to $38,800 for federal income tax purposes for that year.
– Multiple plans example: If you contribute $15,000 to Plan A and later start Plan B during the same year and contribute $10,000, your total $25,000 must not exceed the IRS elective‑deferral limit for that year.
Common mistakes to avoid
– Failing to claim full employer match.
– Losing track of deferrals across multiple employers and exceeding the annual elective‑deferral limit.
– Assuming all plan assets are FDIC‑insured.
– Not understanding Roth distribution qualifications (five‑year rule + age requirement).
Where to find authoritative guidance
– Your plan’s Summary Plan Description and your plan administrator — for plan‑specific rules (matching, how to change deferrals, corrective distribution procedures).
– Internal Revenue Service (IRS) pages on 401(k) limits, Roth designated accounts, distribution rules, and plan operation guides. Examples:
– IRS — 401(k) plan contribution limits and resource guides.
– IRS — “How Much Salary Can You Defer if You’re Eligible for More Than One Retirement Plan?”
– IRS — 401(k) Plan Fix‑It Guide.
– Federal Deposit Insurance Corporation (FDIC) — guidance on what deposits are insured.
Bottom line
Elective‑deferral contributions let you funnel part of your paycheck into an employer‑sponsored retirement plan. They come in pre‑tax (traditional) and after‑tax (Roth) forms, are subject to IRS annual limits, and can meaningfully reduce your taxable income or provide tax‑free retirement income (Roth) if rules are met. To make the most of your plan: capture any employer match, monitor contributions against IRS limits (especially if you participate in multiple plans), and follow your plan’s correction process promptly if you overcontribute.
Sources
– Investopedia — Elective‑Deferral Contribution (summary and examples).
– Internal Revenue Service — 401(k) Plan Overview; 401(k) contribution limits; 401(k) Plan Fix‑It Guide; Retirement Topics and Designated Roth Accounts.
– FDIC — Your Insured Deposits.