Additional Voluntary Contribution: What it Means, How it Works

What Is an Additional Voluntary Contribution (AVC)?

An additional voluntary contribution (AVC) is a term describing an employee's tax-deferred payment to a retirement savings account that exceeds the amount their employer matches. The employee may make additional annual voluntary contributions up to certain approved amounts by the Internal Revenue Service (IRS).

Understanding an Additional Voluntary Contribution (AVC)

Employees can make additional voluntary contributions to tax-deferred savings accounts such as 401(k), 403(b), SEP-IRA, and SIMPLE IRA plans. Roth IRAs and designated Roth accounts don't allow the employee to contribute pretax dollars.

This essentially means that employees may postpone paying income taxes on this portion of their salaries until they withdraw the money upon retirement. With Roth IRAs and designated Roth accounts, the income taxes are paid at the time contributions are made, meaning they are not pretax contributions. However, Roths allow tax-free withdrawals or distributions in retirement.

Employer Matching Contributions

With employer-sponsored retirement plans, employers can match the percentage of the salary that an employee contributes, up to a threshold. For example, an employer might contribute 3% of an employee's salary each year.

The employer might require that the employee also contribute a minimum percentage in order to qualify for the employer match. In some cases, companies offer programs with higher matching maximums, while others offer no matching options of any kind.

Employee Contribution Limits

The IRS has established annual contribution limits for 401(k)s. For 2024, the maximum employee contribution limit per year is $23,000. If you are aged 50 or older, an additional catch-up contribution of $7,500 is allowed.

SIMPLE IRAs have a $16,000 employee contribution limit in 2024. The catch-up contribution is $3,500. SIMPLE IRAs are plans that are offered by companies with fewer than 100 employees.

The contribution limits for employer-sponsored retirement plans are much higher than the limits for individual retirement accounts (IRAs) and individual Roth IRAs. Per the IRS, individuals can contribute a maximum of $7,000 in 2024 to IRAs For those aged 50 and over, they can contribute an additional $1,000 as a catch-up contribution.

In the above employee contribution limits, they do not include employer contributions. If an employer, for example, contributed to an employee's plan 5% of the employee's $50,000 salary, they would add $2,500 to the employee's 401(k).

Let's say that the employee was also required to add 5% of their salary to qualify for the employer match. Any additional employee contributions beyond the employer match of 5% would be considered additional voluntary contributions.

Tax Consequences of Excess Contributions

Additional voluntary contributions may vary in tax treatment, depending on the type of plan. Typically, contributions made to tax-deferred accounts will accumulate or grow tax-free until retirement.

When the funds are withdrawn for retirement, the IRS will levy a 6% tax on the extra amount contributed, and on any investment returns earned by that money every year until then.