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Don't Miss Out on Free Money by Making This 401(k) Mistake

By Adam Levy – Oct 10, 2020 at 8:15AM

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You might think you're getting the employer match all year long, but you'd better double-check.

If you are a good saver, you know the value of maxing out your 401(k) plan and making sure you get the employer match on your contributions. And if you're a really good saver, you may be aware of the benefits of front-loading your 401(k) contributions, adding as much as possible to your plan early in the year. Front-loading maximizes your money's time in the market, which should produce better returns for your 401(k) account in the long run.

But if you're not careful with your front-loaded contributions, you could actually be missing out on a portion of your employer match. That's "free money" you deserve as an employer benefit.

The mechanics of your 401(k) match

Let's say you make $80,000 a year in salary. If your employer matches 4% of your salary dollar for dollar, you would assume that you'll get an employer match on the first $3,200 you contribute to your 401(k). In other words, your account gets an extra $3,200 provided by the employer.

But it doesn't quite work out that way. Your employer, for instance, doesn't know if you'll work 12 full months for the year. It doesn't know whether you'll get a raise midyear or if you'll take lower compensation at some point in the year for extended time off. So, instead of matching your contribution based on your annual salary, employers usually base their matching contributions on your compensation for each pay period throughout the year.

An envelope of cash labeled 401k.

Image source: Getty Images.

So, that $80,000 annual salary breaks down to 24 pay periods of approximately $3,333 each, and your employer's 4% match ends up going toward the first $133 or so that you contribute in each pay period.

If you don't make a 401(k) contribution during a pay period, there's no match.

So, if you stop contributing part-way through the year, you could be missing out on a portion of your match. The reasons for stopping can vary. You might stop because you hit the annual contribution limit early (related to the front-loading of contributions strategy). Or you might stop because you thought you'd contributed enough to guarantee the company match and moved to funding an IRA, a Roth, or some other retirement accounts.

To account for this issue, some 401(k) plans have what's called a "true-up" provision. At the end of the year, the plan administrator will determine how much the company match should've been if you had contributed evenly throughout the year. The company will contribute those funds sometime at the beginning of the year following your contributions. 

Check with your 401(k) plan administrator to see if your plan has a true-up provision. If it does, you don't have to worry as much about missing out on the employer match for contributions you've already made, but you should still consider making changes to how you contribute in the future. That's because if you're terminated or leave your job midyear, you won't get that true-up match at the start of the next year.

How to adjust your 401(k) contributions to front-load and still get your full match

Let's go back to our example of the employee who gets paid $3,333 twice a month and gets a 4% employer match (equal to $133 per pay period). Normally, that person will need to contribute at least $133 (and 33 cents, to be closer to exact) to a 401(k) in each of the 24 pay periods during the year to get their full employer match. That creates a total employee contribution of $3,200 for the year (as well as the employer contribution of $3,200). 

IRS rules in 2020 say that employees can make tax-deferred contributions of up to $19,500 toward their 401(k) plan. That leaves $16,300 in contributions still potentially available to add to the plan. Let's say you want to max out your contributions and your overall budget allows for that level of contribution. You also want to front-load those contributions to enhance your return and you have the discretionary income to contribute $1,000 per pay period (or an extra $867 above the minimum needed to get the match). It takes just a little more math to determine how many pay periods you should maintain elevated contributions to fully max out your 401(k) without missing out on the employer match throughout the year.

Here's the math. If you divide $16,300 by the additional $867 per pay period that you are contributing, you see it will take 18.8 pay periods to cover the added contributions. To make things easy, we will round down to 18. Through your first 18 pay periods, you will have contributed $18,000, leaving you with six pay periods left in the year and $1,500 still to contribute. That means contributing $250 per pay period through the rest of the year to max out your contribution.

Remember to increase your withholdings again at the start of the next year to repeat the process.

There are lots of different scenarios for how to manage this idea, depending on available income and contribution goals, but the overall idea is the same. By doing a little planning at the start of the year can help make sure you don't miss out on the company benefits you deserve while also maximizing your retirement strategy. Plan your contributions to max out your match while front-loading your investments and you'll improve your chances of growing your 401(k) balance as big as possible.

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