Understanding your 401(k) can be confusing but it is an important element of a successful retirement plan. Your 401(k) has many benefits and often those include ‘free’ money from your employer. However, there is strategy involved to maximize this benefit.
If you are able, it may be tempting to contribute as much to your 401(k) account as quickly as possible, but in certain circumstances, doing so may also prevent you from receiving the maximum benefit of matching from your employer. To avoid this scenario you need to understand how companies can contribute to a 401(k) and which applies to you.
For instance, if you work in the airline industry, it may actually benefit you to maximize your 401(k) as early in the year as possible because major airlines typically provide a non-elective contribution to employees (aka “B-fund”). Non-elective means whether you contribute or not, your company will contribute an amount to your 401(k).
Elective Contribution a.k.a Company Match
However, if you do not have a non-elective contribution, it is possible your employer offers a contribution to employees’ 401(k) accounts based on an employee’s own contributions or compensation, also referred to as ‘match’. Most commonly an employer calculates its match as a dollar-for-dollar match, up to a percentage of yearly income OR as a percentage of each dollar you contribute up to a percentage of yearly income.
People often assume this means as long as they contribute a certain amount or more each year they will receive their total employer’s match. However, maximizing your 401(k) contribution doesn’t always mean contributing as much as possible from each of your paychecks. In order to maximize yearly 401(k) contributions from yourself and your employer, you need to know how and when those matching contributions are administered. In other words, your company may be one that stops its 401(k) matching once YOU stop contributing to the 401(k).
Use Strategy to Maximize “Free” Money
As you can see in the example below, by contributing too much too soon, Susan found herself missing out on nearly $10,000 her company would have otherwise contributed if she had spread her contributions out with a strategy. The Pay-per-Period plan is common and if you are not aware of your 401(k) intricacies you may find yourself in a similar situation.
Need help understanding your 401(k) plan? Give us a call, we are happy to go over it with you.
Susan works for a company that offers a dollar-for-dollar match up to 7% of her salary, on a pay-per-period schedule. Susan is 40 years old and makes $225,000 a year, paid bi-monthly (24 times per year). Susan thinks “Christmas spending is over, I’m done traveling, and burning through money. It is time to save up some money!” So, Susan changes her contribution to 25% so she can save early in the year while she has fewer expenses. Keep in mind the 2019 IRS contribution limit for individuals under 50 is $19,000 (+$6000 if over 50).
- Susan is making ($225,000 / 24 pay periods) $9,375 and Susan now contributes ($9,375 x 25%) $2,343.75 each paycheck. Susan’s company matches 7% of her paycheck $656.25.
- After just 9 paychecks Susan has maxed out her yearly contribution of $19,000 and her company has contributed just $5,906.25. Because Susan can no longer contribute to her 401(k) her company stops contributing as well.
- If Susan had instead contributed $791 each month for 24 pay periods, she would have maxed out her personal contribution limit and her company would have contributed $15,750.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this video will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any information or any corresponding discussions serves as the receipt of, or as a substitute for, personalized investment advice from Leading Edge Financial Planning personnel. The opinions expressed are those of Leading Edge Financial Planning as of 03/05/19 and are subject to change at any time due to the changes in market or economic conditions.