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
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.
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