First of all, congratulations that you are able to max out your 401k. Whether it’s $18,000 if you are under 50 years old or $24,000 if you’re over 50, that is a lot of money to sock away on an annual basis.
Now that we have established you're contributing the max, the next question I ask is do you receive matching contributions from your employer? If the answer is yes, another congratulations are in order because not all employers provide a company match.
So, if you are maxing out your 401k and receiving matching contributions, you’re probably asking yourself where the pitfall is I mentioned earlier. Well, what it comes down to is how early in the year do you actually reach your 401k max?
Once you reach your max, you are no longer able to contribute and when you can’t contribute, your employer can’t match because there isn’t anything to match against. You heard me right, once your contributions stop for the year, even if it is because you have met the limit, your employers matching contributions stop as well.
Before I go on though, I will mention that this is not always the case in all 401k plans. If your employer contributes its match as one lump sum at the beginning of the next year, then you are most likely in good shape. However, I would highly suggest checking with your employer on how their matching contributions work because you could potentially be missing out on thousands of dollars every year which could mean hundreds of thousands of dollars in retirement.
Remember, for many employers, the only way they can match contributions is if you’re actually contributing from your own paycheck. If you are no longer contributing because you reached the max earlier in the year, then there’s a good chance you’re going to be missing out on that match going forward.
Let’s take a look at another example using the same $200,000 salary. Now, you’re contributing 18% because you like to fill up your 401k bucket fast so you can get that money back in your paycheck earlier in the year. At this rate, you would reach the $18,000 max at the end of June. Since you won’t have any more contributions going into your 401k for the next 6 months, you could potentially miss out on $6,000 of employer matching contributions!
What’s that look like from a compound interest perspective? At $6,000 per year for 25 years at 8%, that comes to over $438,000! You heard me correctly, over $438,000 dollars!
What can you do to ensure you’re not in this dilemma or can at least correct it ASAP? Check with your employer to determine how they match contributions and what happens if you max out your 401k earlier in the year. If they stop matching contributions once you hit the limit, then I would highly recommend changing your contributions so they are spread out over the entire year. This will ensure you receive the maximum employer matching contributions possible.
Obviously, maxing out your 401k is a good thing. So, you would only assume that maxing it out faster must be a better thing. As you know now that’s not the case with some employer 401k plans. Take the steps today to ensure you are getting the most out of your 401k because as you can see, it can add up to a whole lot of money over time.
Check out Why Maxing Out Your 401k Could Mean Missing Out On A Lot Of Money article as well!
*If your company does pay a match at each paycheck, they should be performing testing to ensure the correct match is being applied even if you to max out early in the year. To correct this, there is a one-time "catch-up" match that is required. This is required by ERISA and should be tested by a third party administrator, but sometimes things do go unnoticed or missed, thus why it's always a good idea to check with our employer to ensure you're not missing out on any match.
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NextGen Wealth, LLC is a registered Investment Advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities product, service, or investment strategy. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor, tax professional, or attorney before implementing any strategy or recommendation discussed herein.
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