Why It’s Dangerous to Contribute too Early to Your 401(k)
Does your employer offer a 401(k) plan? And do they match any of your contributions?
If so, they might only match up to that percentage on each of your checks, and not on how that check amount relates to your total annual salary.
That means deferring too much, too soon of your salary could reduce the amount of those matching contributions.
Here’s an example of how that could happen:
In 2019, you can contribute up to $19,000 of your salary to a 401(k) plus another $6,000 if you are 50 or older for a potential total of $25,000.
Suppose you are 60, just got a fat bonus from last year or maybe your spouse started a new job that includes a hefty pay increase.
Now you have cash to spare and decide to max out your tax-deductible contributions to your 401(k) within the first six months of the year. Then you’ll have the remaining six months to sock away money for a nice vacation over the holidays.
Let’s assume your salary is $75,000 and you are paid twice a month ($3,125). To reach your goal of front-loading your 401(k) by June 30, you’ll have to contribute $2,083 per pay period ($25,000 ÷ 12).
And say your employer matches the first 6% of your salary that you contribute each pay period to your retirement plan. That comes to $187.50 ($3,125 x 6%). Therefore, for the six months you contributed to the plan, your employer put in $2,250.
So far so good. Except for this…
You’ll Miss Out on More Free Money!
The remaining six months of the year you aren’t contributing to your 401(k), which was your goal. But neither is your employer.
Gone is the free money… $2,250 to be exact.
Over many years that can add up, especially when you figure the returns you might earn on those matches.
You Might Be in Luck…
Your 401(k) could have a true-up match.
This optional feature allows you to receive the maximum employer match even if you’ve reached the maximum deferral amount prior to the end of the year.
In other words, an employer-sponsored retirement plan that has the true-match arrangement doesn’t care when you hit the annual cap.
When Front-Loading Could Make Sense
Without an employer match, front-loading your 401(k) is worth considering since your money will have the opportunity to benefit faster from compounded, tax-free growth.
It could also make sense if you are retiring, as this will be the last opportunity to put away more tax-favored money for your golden years.
And even if you are going to another job that has a retirement plan, there might be a waiting period at your new employer before you can participate.
Don’t Be Too Eager To Fill Up That 401(K) Bucket Early In The Year
As you can see, there’s no absolute right or wrong answer on whether front-loading is the right choice for you.
Before you do it though, first check with your HR department.
- What is the match formula?
- How often are matches made… per pay period, monthly, quarterly, or annually?
- Is there a true-up provision?
Then run the calculations.
If you find that you’re going to fall into a deferring-too-much-too-fast trap that will cost you down the road, simply cut back on the amount you are deferring so it’s spread throughout the year.
To a richer life,
— Nilus Mattive
Editor, The Rich Life Roadmap