How to Make the Most of Your 401(k) Leave Early and Get Your Balance Free
January 12, 2023
Many of us have employer retirement plans that match our company. I’m talking about a 401(k), 403(b), 457, or TSP plan, with the most popular flavors listed. If your company matched contributions to your plan by payroll and set contributions to reach maximum deferral limits earlier in the year, you could miss a full eligible employer match. There is a possibility
Let’s take an example using a 401(k) plan. This applies to most of the employer plans mentioned above.
Let’s say you’re 45 years old, earn $150,000 a year, donate 20% of your income to your 401(k), and your employer matches 4% of your income with each paycheck. A 4% match you can win is $6,000 ($150,000 x 4%).
20% of $150,000 is $30,000. With a maximum annual contribution of only $22,500 that year (2023 limit for under 50s), if you contribute 20% of your income, you will reach your maximum of $22,500 in nine months (income and contributions (assuming the amounts are evenly distributed). year), after which you should stop donating. If you stop contributing, your employer may also stop matching contributions. If her employer stopped matching contributions, she would have missed the last three months of matching contributions. in this case, $1,500 free money.
This issue does not affect all 401(k) plans.
If your 401(k) plan has so-called “compensation” contributions/features, no problem. This provision should ensure that even if you maximize your 401(k) plan by the end of the year, you won’t miss out on matching contributions that you would normally be able to receive. “Makeup” contributions are generally made at the end of the year or the beginning of the following year. You can check with your human resources department to see if this feature is in your plans.
Another thing to watch out for is when employers make matching contributions. If your employer matches your contributions by pay period, that can be a problem. Because when your contributions stop, the matching contributions stop too. If your employer makes a lump sum matching contribution, usually at the end of the year or the beginning of the next year, you’re probably fine.
What you should do: Spread your 401(k) contributions. If your employer doesn’t have a “compensation” clause or doesn’t make a one-time lump sum matching contribution, he must spread the contribution over the year. Don’t maximize your 401(k) plan at the beginning of the year. To calculate this, divide your maximum annual contribution by your annual income. So, in the example used above, divide $22,500 (highest annual under age 50) by $150,000 (annual income). In this case, this person would not want to contribute more than 15% of his income ($22,500 / $150,000 = 15%). In the 15% case, this person maxes out her 401(k) plan at her $22,500 and spreads contributions over her year so she doesn’t miss out on her employer’s matching contributions. Problem solved!
Before you read this, if you’ve already contributed to your 401(k) plan this year, here’s a formula to help you understand what to change your contributions for the rest of the year.
- First, calculate contributions for the rest of the year = Annual Limit – YTD Contributions
- Then calculate Remaining Income for the Year = Annual Income – YTD Income.
- Divide your contribution amount for the rest of the year by your income for the rest of the year to find the percentage you want to save for each payment period for the rest of the year.Reset your contributions again on January 1stst.
Don’t leave free money on the table. Good luck and happy savings!