I know that it is a retirement account, so why cant someone put like $10,000 in at once if they have the cash? Also what happens if you do overpay, why is it even possible to overpay in the first place?
In: Economics
Retirement Accounts are used for tax deference. You put in pre-tax money now, and you tax it later. Ideally, the money you’re putting in now is money that would be in a higher tax bracket now, but comes out in a lower tax bracket later (in addition to making interest on all that pre-tax money).
But if you just allowed unlimited contributions, then people could put away a LOT of pre-tax money. The government still wants some of that income tax now, so they set limits on how much you can deposit at once.
Because it is tax advantaged investment, it is dollar for dollar better for high income people compared to low income people. So if someone has to pay 40% of their last dollar earned on income tax, investing that last dollar in a 401k means that person reduces their taxes by $0.40. If someone has a marginal tax rate of 15% (ie lower income), then that same dollar saves this person only $0.15.
In this way, an unrestricted 401k is EXTREMELY tax beneficial to very high income folks who can simply put away as much as they want. Say someone earns $2m/year (which would be taxed on average at 30% so around $600K). Well then they could put in $1.9m into the 401k reducing their taxable income to 100K and now their tax rate might be only 18% meaning their taxes is only $18K. In essence, they saved $582K on taxes while growing a huge retirement portfolio that they can liquidate at lower tax rates after they retire and no longer earn $2m/yr. This would be terrible as a regressive tax and very bad for government tax revenue.
So to make this program focus the benefits on the lower to middle class earners, 401k contributions are capped which means the $2m/yr income earner pretty much has to pay their full taxes.
The main reason to get a 401k is that you get to delay your taxes until you retire. Instead of paying income tax you can put your cash in a 401k where you get to earn interest on that money. Of course you pay taxes when you withdraw the money but now you have a lot of interest from this which increases the amount of money you get.
For the governments point of view a 401k therefore loses them money as they don’t get to collect tax on it. This is why they have a contribution limit on it. They don’t want people to put all their income into a 401k as they would not be able to collect tax on it.
TLDR: A 401k allows you to exclude some of your earnings from income tax until you retire. If there was no limit than higher earners would throw all their money in there and wouldn’t pay income tax.
The US government created these tax-deferred and tax-advantaged savings accounts to encourage middle-class people and their employers to save for retirement and take advantage of some tax relief as they age.
What they very specifically *didn’t* want to do was give the wealthy an additional lever to pull to try and dodge taxes.
So 401k and Roth accounts have annual contribution limits intended to cap the amount you put in at something relatively reasonable for the upper-middle class. We don’t want Jeff Bezos putting 80 billion dollars in a Roth IRA so it can grow tax free or attempting to defer millions of dollars on executive compensation into a 401k.
It’s possible to overpay because the government doesn’t know how many jobs you have or if you plan to work at your current job all year. Maybe you’re planning to leave in July so you set the withholding rate really high because you need twice the money to make up for no withholdings in the back half of the year.
Then you change your mind and stay, and overpay.
You should check out r/personalfinance if you want to learn more
>ELI5: Why does the 401k have a contribution limit?
The US government wants to help people save for retirement by giving you a tax incentive to do so, but that means they don’t collect tax revenue on that money this year. They have a pain tolerance for how much tax revenue they are willing to not collect.
Also, rich people would put almost all of their income in there for the tax shelter, so the rich would get richer. So the limit also helps keep the world a little less unfair. [https://www.investopedia.com/ask/answers/082515/why-are-ira-roth-iras-and-401k-contributions-limited.asp](https://www.investopedia.com/ask/answers/082515/why-are-ira-roth-iras-and-401k-contributions-limited.asp)
>so why cant someone put like $10,000 in at once if they have the cash?
You can make lump sum contributions into an IRA (2024 limit is $7,000). But 401ks and 403bs (2024 limit is $23,000) are workplace retirement plans, so Congress simply wanted to make it a rule where you can only contribute via payroll deduction. It doesn’t always have to make sense either.
>Also what happens if you do overpay, why is it even possible to overpay in the first place
Most (nearly all) 401ks will automatically shut off your payroll contributions once you hit the limit. But if you have switch jobs there’s really no way for Job A to know about Job B, so people can and do overcontribute by mistake in those instances.
If you do overcontribute, you have to remove the excess before next tax filing deadline by calling your current employer. Not that complicated [https://www.irs.gov/retirement-plans/consequences-to-a-participant-who-makes-excess-deferrals-to-a-401k-plan](https://www.irs.gov/retirement-plans/consequences-to-a-participant-who-makes-excess-deferrals-to-a-401k-plan)
**Because the government wants you to pay taxes.**
Money put into a 401(k) account doesn’t count towards your total you made for the year when you file your taxes. So they limit how much you can save to make sure they’ll collect taxes on most of your income.
At the end of the year, the company that manages the 401(k) will do some calculations, and refund that money to you, and you’ll get a check and have to include that when doing your taxes.
There’s a few ways to go over. If you change jobs in the middle of the year, the second company doesn’t know what you put in with the first. Or if you’ve really highly paid, there’s some rules on the 401(k) plan that limit you if lower paid employees don’t use the 401(k) to a certain percentage.
It’s also why there’s a requirement to withdrawal when you hit a certain age, the government wants you to pay taxes on that money before you die.
taxes. that’s your answer. The government doesn’t want people sheltering their money from taxes.
They want you to save money, because a bunch of broke old people is bad for the economy, so they allow you to save money tax free, but they don’t want people to be able to hide 99% of their income in a tax free shelter (which a very wealthy person could do)
If I make 20M a year but only need like 200k, I could just put the rest in my retirement account every year, and the government sees almost none of my money for the next 50 years or more if ever depending on how crafty my beneficiary is with it after I die.
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