Annual Addition

What Is the Annual Addition?

The annual addition is the total dollar amount that a participant contributes to their retirement account under a defined-contribution (DC) retirement plan, such as a 401(k). The annual addition is subject to a maximum limit, which is generally the lesser of 100% of a plan participant's compensation for the year, or the dollar amount of the limit that's in effect for a particular year. The annual addition is the total contribution limit for both the employer's matching and the employee's contributions.

Understanding the Annual Addition

The term annual addition is another way of saying "total contribution." The Internal Revenue Service (IRS) limits how much you may contribute to your defined-contribution retirement account in any one year. This limit applies to the total annual contributions (additions) to all of your accounts in plans maintained by one employer (and any related employer). In some 401(k)s, for example, employers might match the employee's contributions by contributing to the employee's 401(k) up to a specific percentage of the employee's salary.

The limit applies to the total of:

Below are the IRS limits for total contributions to a defined contribution retirement plan for 2020 and 2021. The annual additions paid to a participant’s account cannot exceed the lesser of:

Annual Additions and Defined-Contribution Plans

Annual additions apply to defined-contribution plans. These types of retirement plans are typically tax-deferred, yet withdrawals are taxable. The tax-advantaged status of defined-contribution plans generally allows balances to grow larger over time compared to taxable accounts. There are many different types of defined-contribution plans, including the 401(k) and the 403(b) plans, in which employees contribute a fixed amount or a percentage of their paychecks.

In order to help retain and attract top talent, a sponsor company will generally match a portion of an employee's contributions in a DC plan. Defined-contribution plans restrict when and how each employee can withdraw funds without penalties. Other features of defined-contribution plans include automatic participant enrollment, automatic contribution increases, hardship withdrawals, loan provisions, and catch-up contributions for employees aged 50 and older.

Annual Additions and Vesting Periods

When beginning with a new employer, an employee must often wait for years to begin receiving annual additions to their retirement plan. Although an employee usually can start contributing to a DC plan sooner, this benefit is frequently delayed to ensure that the employee stays in the position long enough to begin adding value to the company and that it’s worth the employer’s time to invest in them. Vesting periods, or a vesting schedule, are generally determined when negotiating the terms of the job.

This type of negotiation is common in many start-up environments, where vesting with stock bonuses can help sweeten the pot for a valued employee to remain with the company. For example, an employee’s stock could become 25% vested in the first year, 25% in the second year, 25% in the third year, and fully vested after four years. If the employee leaves after just two years, they could forfeit 50% of their vesting capabilities. 

In some cases, vesting is immediate, as with employees’ own salary-deferral contributions to their retirement plans. Further, individual retirement account (IRA) plans like the SEP and SIMPLE require that all contributions to the plan are always 100% vested.