Why would an employer limit their employees' 401(k) paycheck deduction?

Question

Some employers limit their employees' 401(k) paycheck deduction. For example:

The maximum contribution to Pre-tax 401k deferral, Roth 401k deferral, After tax is 65 percent.

Why would an employer limit their employees' 401(k) paycheck deduction?

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2 reasons not to limit employees' 401(k) paycheck deduction:

• Employees hired mid-year, or employees who change their mind over the course of the year, may benefit from being able to contribute to more than 65%.
• This year's 401(k) total defined contribution plan limit is $54,000, which typically takes a significant number of paychecks to hit, hence the potential usefulness of deducting more than 65% of one's paycheck.

Answer 1

Contribution plan limit from an employee's salary is only $18,000

The rest of the $54,000 limit comes from employer contributions such as matching.

That aside, the percentages of salary that you can contribute is arbitrarily set by the employer and they most likely have no rationale behind it and have no idea it is even set that way and have no idea who the plan sponsor is who has the access to change that amount.

Answer 2

Employers typically don’t develop completely new plans, but sign up with some provider for some standard. There is a cost for them, and there are certain predefined offers, and they picked one - probably for reasons unrelated to the 65% limit.
Some plans are limited to 90%, some are limited to 25%, or whatever they got offered.

Another potential reason to limit is the legal HCE limit (HCE = Highly Compensated Employee) - companies with broad income spreads might have the problem that the higher earners save a lot (because they can or because they are better educated about it), and the distribution becomes so uneven that the HCE laws get them in trouble. By limiting the percentage, they cut a bit a the high income end, which gets them back to where they need to be.

Answer 3

The main reason to limit employee's 401k contributions is because the IRS imposes limits. It's not the employer making that decision, it's the government.

The government has an obvious reason to limit contributions: They reduce tax revenue. The government has decided that it wants to encourage and facilitate people saving for retirement, but it puts limits on this to prevent people from taking advantage of the rules and using it for other purposes, or from getting an "unfair" tax advantage.

There are also "non-discrimination" rules intended to prevent a company from setting up a retirement plan that benefits only the owner and maybe a few top executives. So if too high a percentage of the money in a plan is coming from high-paid employees, the company has to impose extra limits to balance it. These rules are fairly complex.

That said, I am not aware of any 65% rule. The government limits on 401k contributions are: $18,500 per year ($24,500 if you're over 50), or 100% of your gross income, whichever is less. It's possible that this is part of a scheme to comply with the non-discrimination rules.

In any case, do you really want to put over 65% of your income toward retirement? What will you live on? Great if you can manage it, but you've got to be a rare case. I suppose there might be some number of two income household that could live on one person's income and put most or all of the other person's toward retirement.