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A while back, one of my daughters made my day by asking me a question.
A question may seem like an odd thing to make one’s day, but this one did… She asked me how to make the most of her employer’s 401(k) match.
This made my day for several reasons.
Unfortunately, not all employers match their employees’ contributions to retirement plans like the 401(k). Even those who do match, don’t necessarily match equally.
The IRS doesn’t allow unlimited contributions to your 401(k).
As of this writing, the limit on employee contributions for 2020 is $19,500 a year, with another $6500 a year “catch-up” allowed if you’re 50 or over.
Employer contributions are limited through the overall contribution limit of $57,000, or $63,500 including the catch-up for those 50 or older.
Since the limitation is on your full-year contribution, you could in principle max out your contribution early in the year. If your employer is one of those who match contributions, but only on a per paycheck basis, you could miss out on a portion of the match.
Here’s how it could work.
Say your salary is $120,000 paid semi-monthly – a nice round $5,000 per paycheck; and you’re younger than 50, so your employee contribution is capped at $19,500 a year, or 16.25% of your salary.
Say also that your employer gives you a $20,000 bonus in your first January paycheck, for the previous year.
You decide to contribute to your 401(k) the full year’s $19,500 in January, so it has the most time in the market to grow. It’s all coming from your bonus, so it doesn’t affect your day-to-day finances. That’s because your budget is built on your $10,000 monthly income without counting on bonuses to cover rent and groceries.
If your employer match is dollar-for-dollar up to 3% of your regular paycheck, you’d get the maximum $150 match for the January pay period in which you contributed the full $19,500 (3% of $5000).
Since you’ve hit your annual limit in your first January pay period, you don’t contribute anything for the rest of the year. That means that you only get a $150 employer match for the full year!
Some employers make sure to avoid this problem by not placing any limit on a specific pay period’s match or by completing their year’s match at the end of the year to address exactly this sort of problem.
Make sure you understand how your employer’s match works. If they aren’t one of those who sidestep the problem, you need to be strategic in how you set up your contributions. Do this by dividing your contributions equally between pay periods across the entire year.
In the above scenario, that would mean dividing the $19,500 by 24, leading to a per-pay-period contribution of $812.50. Use an online calculator to figure out the best strategy for your individual case.
As described by US News and World Report, here’s a cheat-sheet for maximizing your 401(k) balance.
While you can’t change how your employer matches your 401(k) contributions, you can strategize how you contribute to make sure you don’t leave any free money on the table.
Disclaimer: The information in this article is not intended to encourage any lifestyle changes without careful consideration and consultation with a qualified professional. This article is for reference purposes only, is generic in nature, is not intended as individual advice and is not financial or legal advice.