If your employer offers 401k matching for your contributions, chances are you can get more bang for your buck just by using a few simple techniques. Sure it’s crucial to make sure you have the right investments within your 401k. But it’s far more important to get the most matching you can. It’s free money and it’s a guaranteed return. Sweet.
As a refresher, your 401k plan allows you to set aside a certain amount of money pre-tax and invest it to help provide for your retirement. Many employers offer matching dollars. That means for every dollar you contribute, the boss will throw in a certain amount. Typically they’ll contribute some percentage of what you contribute up to a limit. This is where the opportunity is and it’s why it’s so important to know how much to contribute to your 401k.
1. Maximize Your Contributions
Let’s say your employer kicks in 50% of every dollar you contribute up to 6% of your gross salary. Keep in mind that employees aren’t usually limited by this 6%. The maximum you can contribute to a 401k in 2013 is $17,500. The IRS doesn’t care what percentage you contribute as long as you don’t invest more than this $17,500 limit. Employers on the other hand can limit your contributions at any level they like. Usually it’s 10% of your salary but this varies by plan. Back to our example.
Let’s say you earn $120,000 a year or $10,000 a month. If you decide to contribute only 3% of your salary to the 401k, that’s $3600 a year. In that case, your employer will only contribute $1800.
But if you contribute 6% instead, that comes to $7200 a year and your employer sweetens the pot with another $3600. So rule number one is to maximize your contributions at least up the point where you snag the maximum amount possible from your employer.
2. Don’t Trust – Verify
In most cases, you don’t have to worry about 401k employer fraud but you do have to keep you eye on the boss. That’s because while your employer may offer to contribute a maximum amount but she won’t force you to take that gift. Let’s go back to our example above. The employer is willing to contribute 50% for every dollar you put in up to 6% of your salary. But don’t assume that your boss is going to set that up automatically.
You have to contact the HR department every year to make sure nothing slips through the cracks. Often, the default is set far below the maximum and that’s going to hurt you in several ways if that’s the case in your situation.
First, your contributions will be reduced and that means you’ll pay more income taxes and fail to maximize your retirement savings. Also, if the 401k defaults to a reduced amount at the start of the year that means the employer match is lower. You can make sure this doesn’t happen to you by simply touching base with HR every January to make sure everything is on the up and up.
3. Don’t Rush
If you are a highly compensated individual you may be tempted to sock as much as you can into your 401k as soon as you can. That can be an expensive blunder.
Let’s say you are a big cheese and earn $360,000 a year – or $30,000 a month. Let’s also assume that your employer allows you to put 20% of your salary into your 401k. Let’s further assume that your employer matches 50% for every dollar you do contribute to the plan up to a maximum of 6%.
Since your boss allows you to put 20% of your salary into the 401k plan you sock away $6000 every month. That’s impressive – but not smart. Here’s why. Each time you sock away $6000, your boss puts in another $900. That’s because they only match 50% of your contributions on the first 6% of your salary.
Keep in mind that once you contribute a total of $17,500 you won’t be able to contribute any further for the year. So if you continue contributing $6000 per month you’ll be done in about 3 months. But in three months, your boss would have only contributed $2700.
On the other hand, if you spread your contributions evenly throughout the year, you will squeeze much more out of the folks in the corporate office. Let’s go back to our example above. But instead of contributing the full 20% your employer allows for, throw in only 6% per pay period.
6% of $360,000 is $21,600 which exceeds the limit of $17,500. That means you’ll probably stop making contributions sometime in November. But you’ll still get a lot more from your employer. If you contribute 6% of your monthly pay, that means you’ll be contributing $1800 a month into the plan and your employer will kick in $900. But this time your boss will contribute for 11 months rather than 3. Her total contributions will be 50% of $17,500 or $8750 which is far better than $2700 you would receive if you front- load your contributions.
4. Take Advantage of Your Age
If you are 50 or better, you can bump up the ceiling on your contributions by another $5500 so the maximum becomes $23,000. Make sure you use this catch-up provision wisely. See the example I used above.
5. Stay on Top of It
Some 401k plans ask you to select an amount you want to contribute rather than a percentage of pay. That’s fine. But remember that things change. The maximum annual contribution (set by the IRS) often goes up every year. If you don’t find out about those increases, you may be missing out on saving for your retirement and more employer contributions.
Maximizing your 401k employer contributions isn’t rocket science. Just understand the ground rules as explained above and review your pay stub twice a year to make sure you’re on track.
What other ideas can you share to help us maximize 401k plan employer contributions?
Some companies offer “true up” like Southern California Edison. If you do finish contributing to your maximum of 17.5K in 6 months, the company will still keep on matching to your 401k throughout the year. Double check.
Point 3 is a good one, and worth keeping an eye on. My wife’s employer has done something very nice in this regard, they call it a “true-up” contribution. What it does is take care of people in your examples, and at the end of the year (actually beginning of the following year) they make an additional contribution for a match that didn’t get made because of hitting the limit early. So if you finish early because of limits on total contributions, they will “true-up” your match to the full 50%.
Do you know if there is a law that provides a time-frame for employers dictating when they should place your contributions in the 401k account?
At the beginning of the year, my wife had her 401k contribution taken out of her paycheck, but it did not show up in her account until 15 days later. She lost out on buying at a lower price, thus losing out on potential gains.
On the other hand, my contributions make it into my account in a timely manner. Usually the following Monday after being paid. I’m not sure why this variation exists. Basically, her employer held her money (not including their match) for 15 days without interest.