If you are a person who:
- Contributes the maximum amount to 401k AND
- Your employer matches contributions
Make sure you understand HOW and WHEN your employer contributes its match; by Lump Sum or every paycheck. The most common form of employer matching is done in every paycheck.
The IRS maximum annual amount for an employee to contribute to a 401k plan in 2022 is $20,500. If your employer contributes its match in every paycheck, then you will want to make a 401k contribution in every paycheck. You do not want to reach the $20,500 maximum in the middle of the year and miss out on free money from your employer. In simpler terms, once you hit the max you will stop making 401k contributions on your paychecks. And if you are not contributing to your 401k, then your employer no longer is required to match. I realize this sounds crazy, but it’s common practice in many 401k plans.
How do you know the proper % to contribute to your 401k to avoid this issue? If your employer allows for fixed dollar amount contributions, then divide $20,500 (the max) by the number of annual pay periods. If your employer requires you to contribute based on a % of your income, then divide $20,500 by your current salary.
As an example, let’s say your annual salary is $300,000, you get paid once per month, and your employer provides a match of 4% and makes it match every month alongside your contribution. Then the contribution % needed to reach the max and contribute to your 401k in every paycheck is 6.83%. At the end of the year, you would have contributed $20,500 to your 401K and your employer’s match would be $12,000.
But if your 401k contribution was set to 10% then you would hit the max contribution limit of $20,500 in August. You would have still contributed $20,500, but your employer’s match would only be $9,000. Thus, you would be leaving $3,000 on the table.
What’s the best way to avoid this scenario?
- Reach out to your company’s 401k provider and ask:
- How does the matching program work?
- When are the matching contributions made?
- Are company matches only given in paychecks when employees are contributing to the 401k plan?
- Is there a “true-up” provision that is offered in the 401k plan where your employer gives your full match at the end of the year?
- Understand the annual maximum 401k contribution that the IRS sets each year
-
- Do the math and calculate your contribution % appropriately to ensure you are making 401k contributions in every paycheck.
-