Last week, in the first topic for this year’s Retirement Season, I discussed a lesser known tactic for contributing more to a 401(k) on an after tax basis that could result in a Super Roth IRA. I’ve heard from some of you that your company’s 401(k) doesn’t allow for those after-tax contributions, which is a plan specific feature. What you can do in these cases is ask your benefits office to consider amending their plan. Your company, as the plan sponsor, has a duty to put your interests (the participants) ahead of their own, so by asking, you are expressing to them that offering this feature may help them show they are fulfilling their fiduciary responsibility. Hey, it's worth a shot, right?
Are you Leaving 401(k) Meat on The Bone?
While we are on the subject of 401(k)s, let’s talk about making sure you are maximizing your plan's potential. First off, the elective deferral maximum for 2018 is $18,500 (plus another $6,000 catch-up amount for those age 50+). If you don’t update your deferral percentage, you may not be fully taking advantage of your pre-tax saving opportunity.
Exhibit 1. 401(k) Plan Limits by Year
For example, if you make $100,000 and were contributing 18% to your 401(k), you would have maxed out your 2017 contribution at the $18,000 limit. However, if you don’t up the percentage for 2018, you will be $500 short of what you potentially could have contributed this year.
Exhibit 2. 18% 401(k) contribution on a $100,000 salary 2017 versus 2018.
If you just turned 50, you could be leaving significantly more meat on the bone. In the same example as above, you would need to increase your deferral amount to 24.5% this year to reach the maximum contribution. If you didn’t already do that for your January and February salary, you may even need to increase it to a higher percentage for the rest of the year.
Don’t Leave Matching Money on the Table
For those fortunate to earn even higher salaries, there is a potential caveat to having too high of a salary deferral percentage. The result could be leaving some company matching contributions on the table.
Here is an example of how it can work. An employee (under age 50) earning $240,000 works at a company that matches 50% of the first 6% of compensation in each pay period that salary deferrals are made.
For the sake of the example, let’s say that the salary is received in equal monthly amounts of $20,000 per month. The employee wants to get as much into the 401(k) as early in the year as possible to take advantage of more time in the the market, so he or she defers 25% of their compensation. At that rate, he or she will max out the pre-tax salary deferral in April. The match, based on the salary received while making salary deferrals, would stop at that time at around $2,400.
If the same employee were to contribute only 8% to their 401(k), the maximum contribution wouldn’t be reached until year end, but the matching contributions would continue and would reach $7,200, as seen in Exhibit 3.
Exhibit 3. 25% deferral versus 8% deferral on a $240,000 salary.
In some cases, plans offer a “true-up” feature that will determine if you could have received a larger match with a lower contribution percentage and will make up the difference at year-end. The only way to know for sure is to contact your benefits office or plan provider.
If you aren't sure if you are getting the most out of your retirement plan, get in touch for a free review.