Are You Missing Out On Free Money By Maxing Out Your 401k Early In The Year?

People with high income and/or who max out their 401k plan early in the year could be missing out on free employer matching contributions.

Most employers match employee contributions each paycheck throughout the year. For example, assume you earn $10,000 per month and your employer matches 6% of your salary. Each month, you contribute 10% or $1,000 and your employer would match it with $600. Your total contributions for the year would be $12,000. Employer matching contributions would be $7,200 for the year.

Let’s say you decide to max out your contributions at 15% of your salary. If you make the contributions evenly throughout the year, you would contribute $1,500 per month and your employer would contribute $600 per month. This is good and so far there are no problems.

But, what happens if you decide to front-load your contributions early in the year when you receive a bonus or have higher sales commissions? Now, there may be a problem because many plans stop matching once employee contributions max out. For example, assume you receive a bonus early in the year that is large enough to meet your annual contributions limit by July. Because you have maxed out your annual limit, you no longer make contributions August through December. The problem is that your employer may stop making contributions also. In this case, you would only receive 6% on your compensation through July. You would miss out on $3,000 of possible free money from August through December.

If you are a high-income earner and/or max out your contributions early, it is important you ask your employer about the plan’s matching policy. Some employers utilize “true-up” policies that calculate how much you would have been owed from them if you had made contributions evenly throughout the year. If that amount is higher than the actual amount they matched for you, the company makes an adjustment.

According to the IRS, incorrect employer matching contribution calculations is one of the three most common mistakes made by companies who sponsor retirement plans. If your company does not use a true-up policy, then review the plan summary document to determine the method the employer must use to calculate their match. Employers can match by pay-period or on an annual basis. If the former, you will want to adjust your contributions so they are even over all pay periods throughout the year to optimize the employer match. If the latter, the company must make true-up contributions or be in violation of the law and subject to IRS penalties. It is also probably a good idea to review your paychecks regularly to make sure contributions are accurate.