We’re going to focus on understanding your employer’s 401k contribution options and how to make them work for you. Note that the 2019 IRS limit for employees contributing to their IRA is $19,000 annually, up from $18,500 the previous year. An additional $6,000 catch-up contribution can be made for individuals over 50 years old.
Most people tend to think that front-loading their 401k is ideal, because you take advantage of tax-deferred contributions early in the year then have a bigger paycheck towards end of the year. For example, by November 1, you’ve met your yearly-max, so for the rest of the calendar year, your biweekly paycheck is slightly larger because you’re no longer contributing to your 401k.
This could be a big investing mistake. If your employer has a matching 401k contribution plan, you’ll could potentially miss out on those matching contributions during the part of the year when you yourself aren’t contributing to your 401k.
One thing to be cautious of in front loading your 401k is when employers make their contributions. These little details can be found in the summary plan description. The summary plan description is a document that employees must provide to the employees who participate in the covered retirement plan. This document will help provide clarity on questions such as:
- When do employees become eligible to participate?
- When do benefits become vested?
- Is it a safe harbor plan?
- How are benefits calculated?
- How are benefits paid?
- How do you claim benefits?
- $100,000 Income
- 6% Employee Contribution
- 3% Employer Match
- 24 Pay Periods in a calendar year.
Some employers will make the matching contributions at the same time the employee contributes to the plan via payroll deduction without restriction.
If you front loaded your contribution on your first paycheck in January, then you would contribute $6,000 and the company would match $3,000 for the month of January and you would not be eligible for any more matches from your employer. However, you could still contribute an additional $13,000 to total the $19,000 max contribution set by the IRS for 2019.
Other employers match is based on each pay period. This simply means that you must be contributing to your 401(k) plan during each pay period for the calendar year to be eligible for the full match. The employer is going to spread their $3000 match among the 24 pay periods totaling $125 match per pay period. If you front load your 6% Contribution in January you would only be eligible for 1 of the 24 matches or $125. This mistake would end up costing you $2,875 in employer match funds.
To avoid this mistake you would spread your $6000 contribution over the same 24 pay periods. You would be contributing $250 per pay period and you would be earning $125 in match per pay period.
Don’t feel bad if you’ve made this mistake; it’s easy to do but also easy to fix. Most employers allow you to make 401k contributions changes any time of year.
Check your 401k language every year; subtle changes in policy and language can greatly affect your finances. If you have any questions or need help translating your employers’ 401k plan or summary plan description, reach out to a CERTIFIED FINANCIAL PLANNER™ Professional.
Create The Life You Love®
If you have not taken the steps to Create The Life You Love®, or if you would like to review your plan, Jonathan P. Bednar, II, CFP® may be reached at 865-251-0808 or Jonathan@ParadigmWP.com www.ParadigmWealthPartners.com
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy can ensure success or protect against loss.