Andy Flack, MBA, CFP®
Too Fast To Stash
Updated: Feb 15, 2019
How Maxing out your 401(k) Early Can Hurt.
If you are maxing out your 401(k) before the end of the year, you may be missing out on matching employer contributions. Here’s how:
Let’s say John makes $260,000 per year so each of his 26 paychecks are $10,000 before taxes. If John contributes 10% into his 401(k), that comes to $1,000 per paycheck. Now let's say John’s employer matches only a maximum of the first 3% of each paycheck — $10,000 x 3% = $300. Since John is under 50, he can only contribute up to $19,000 per year from his salary. At this pace, he will max out his 401(k) contributions on the 19th paycheck ($1,000 x 19 = $19,000). That means that his employer will only match for those 19 pay periods which comes to $300 x 19 =$5,700.
Now let’s see what would have happened if John had done things a bit differently. If he contributed only 7.3% of his salary, that would come to $730 per paycheck. The company match would be the same since they only match the first 3% of each paycheck — $300. But because John will be able to make contributions through all 26 pay periods, his company will match $300 x 26 =$7,800!
If John still has extra money to invest after the 7.3% contribution, he can always invest in an after-tax brokerage account earmarked for retirement - there are no maximum amounts or income limits with this type of account. In fact, there are probably more investment choices than there are in his 401(k).
Unless your 401(k) has a feature called “true up” or if they match on an annual basis (not per paycheck), you may be missing out on matching contributions by front-loading your 401(k) too quickly. Without these features, if you plan on contributing to your employer’s plan for an entire calendar year, you may be better off spreading the contributions evenly throughout the whole year. Everybody’s situation is different so I recommend speaking with a financial planner (such as myself) or a CPA to address any questions you may have before changing your strategy. I hope you find this information helpful and invite you to contact me with any questions.