Pension Plan Limits on Contributions and Benefits

The federal government establishes annual limits on the amounts that can be contributed to and received from tax-advantaged retirement plans. The Internal Revenue Service (IRS) evaluates and adjusts them each year for cost-of-living increases. The purpose of these regulations is to cap the tax benefits associated with these retirement vehicles, such as tax-deferred growth and deductions for contributions. By setting these maximums, the government balances the goal of encouraging retirement savings with the need to manage tax revenue.

Defined Contribution Plan Limits

Defined contribution plans, like 401(k)s or 403(b)s, have specific annual limits on account contributions. These limits are broken into distinct categories for employee and employer contributions. Understanding these separate thresholds is important for maximizing savings potential while complying with federal tax law.

Elective Deferral Limit

The elective deferral limit is the maximum amount an employee can contribute from their salary into their retirement plan. For 2025, the IRS has set this limit at $23,500. This amount is a direct reduction from an employee’s paycheck, often on a pre-tax basis, which lowers their current taxable income. This ceiling applies to the total of all elective deferrals an individual makes in a year, even if they contribute to multiple plans.

Catch-Up Contributions

To help workers closer to retirement age accelerate their savings, the tax code allows for catch-up contributions. Employees aged 50 and over can contribute an additional amount above the standard elective deferral limit. For 2025, this catch-up amount is $7,500, allowing an eligible individual to contribute a total of $31,000. A separate, higher catch-up limit of $11,250 applies for employees aged 60, 61, 62, and 63 for 2025.

Annual Additions Limit

The annual additions limit is a comprehensive cap on the total amount credited to a participant’s account in a single year. This includes employee elective deferrals, employer matching funds, and any other employer contributions like profit sharing. For 2025, this overall limit is the lesser of $70,000 or 100% of the participant’s compensation. For example, if an employee under 50 earns $80,000 and defers $23,500, and their employer contributes a $10,000 match, the total annual addition is $33,500, well below the $70,000 ceiling.

Defined Benefit Plan Limits

Defined benefit plans, or traditional pensions, differ from defined contribution plans as their limits cap the total benefit an individual receives in retirement, not the annual contributions. The primary constraint is the maximum annual benefit a plan can provide. Per IRS rules under Section 415, the 2025 benefit is limited to the lesser of $280,000 or 100% of the employee’s average compensation for their three highest-paid consecutive years.

This dollar limit assumes benefit payments begin at age 62 or later. If a retiree starts receiving their pension earlier, the maximum permissible annual benefit is actuarially reduced to reflect the longer payment period.

Key Compensation and Employee Thresholds

The IRS also establishes financial thresholds integral to plan administration. These figures determine how much of an employee’s pay can be considered for plan purposes and how employees are classified for compliance testing. These definitions are foundational for ensuring a plan operates fairly and within legal bounds.

Annual Compensation Limit

A cap exists on the employee’s annual salary that can be used for calculating retirement contributions or benefits, known as the annual compensation limit. Under Internal Revenue Code Section 401, this limit is $350,000 for 2025. If an employee earns more, any employer contributions or benefit calculations must be based on a salary of no more than $350,000.

Highly Compensated Employee Threshold

For nondiscrimination testing, plans must distinguish between highly compensated employees (HCEs) and other employees. An HCE for 2025 is an individual who either owned more than 5% of the business during the current or preceding year, or received compensation over $155,000 in the preceding year. If the employer elects, the HCE must also have been in the top 20% of employees by compensation. The compensation threshold for determining HCE status in 2025 will be $160,000 for the 2026 plan year.

Key Employee Definition

The “Key Employee” classification is used to determine if a plan is “top-heavy,” meaning more than 60% of its assets are in key employee accounts. For 2025, a Key Employee is an employee who was an officer earning over $230,000, a more-than-5% owner, or a 1% owner with annual compensation over $150,000. This definition is for a top-heavy test that may require minimum contributions for non-key employees.

Correcting Excess Contributions and Deferrals

When contributions exceed legal limits, corrective actions are required to avoid plan disqualification and tax penalties. The process for fixing these errors depends on which limit was exceeded, and failing to address them in a timely manner can lead to penalties for both the employee and the employer.

If an employee exceeds the elective deferral limit ($23,500 in 2025), the excess amount and its earnings must be distributed back to them. To avoid double taxation, this distribution should be completed by April 15 of the following year. The returned excess contribution is taxable in the year it was originally deferred.

The earnings on the excess deferral are taxable in the year they are distributed. For example, if an excess deferral from 2024 is returned in March 2025, the principal is included in 2024 taxable income, while the earnings are included in 2025 taxable income. Missing the April 15 deadline means the excess is taxed when contributed and again when distributed.

Correcting a violation of the annual additions limit ($70,000 for 2025) depends on the plan’s document. The plan may specify an order of correction, such as returning after-tax employee contributions first, followed by pre-tax deferrals. Alternatively, the plan might require employer contributions to be forfeited and placed in a suspense account to reduce future employer contributions.