Author Topic: Optimizing 401k contribution  (Read 6952 times)

AnnaD

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Optimizing 401k contribution
« on: July 19, 2012, 10:13:00 AM »
Hi guys!  1st time poster, been reading a while though.

I realize this is a good problem to have, but I am uncertain the best way to set my contribution limits in order to max out my 401k contribution next year taking into consideration my bonus income.

If I hit max before the end of the year then I lose the remaining employer match, but if I underestimate then I'll not meet the limit.  I can only change my contribution percentage in December and June to take effect the next month.
The problem is I can not predict my bonus income.  For example last year I made 70% of my bonus income in the last 4 months of the year, but this year has been very dry and the outlook is pretty bleak for attaining the same level of bonus income.

I've considered placing the bulk of my contribution at the beginning of the year and then re-evaluating in June to reduce the contribution %.  If at the end of the year I have not met the 401k limit I could place that money into a traditional IRA.  I don't really want to do that as it would be yet another account to maintain and would take a while before the scrap contributions added up to enough for investment purposes.

How do others handle this?  Can you awesome 'Stachers give me some advice in this area?

Thanks!

Note: I already max out my Roth IRA and my HSA.

bogart

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Re: Optimizing 401k contribution
« Reply #1 on: July 19, 2012, 10:35:35 AM »
I'm not sure I understand the source of your problem.  Is it caused by uncertainty about how much money you have available to you (if your bonus is too small, you can't contribute the annual max because you can't afford to), or because of some quirk about how your employer funds a match?  My employer's match is mundanely simply to grab, but yours may not be, and if that's the problem, knowing more details will probably be necessary to help you figure it out.

grantmeaname

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Re: Optimizing 401k contribution
« Reply #2 on: July 19, 2012, 10:40:37 AM »
See if your plan requires your employer to make catch-up contributions at the end of the year if it has undermatched you.

AnnaD

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Re: Optimizing 401k contribution
« Reply #3 on: July 19, 2012, 10:49:45 AM »
Correct me if I am wrong but if I set up my contribution to max out and due to bonus income I max before the end of the year then I will not receive any more employer contribution?  Thus leaving "free" money on the table.  Yes? No?

velocistar237

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Re: Optimizing 401k contribution
« Reply #4 on: July 19, 2012, 10:51:25 AM »
My employer allows me to specify either a percentage or a dollar amount, so I set my contribution amount to $17000/(number of pay periods per year). Is that not an option for you?

grantmeaname

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Re: Optimizing 401k contribution
« Reply #5 on: July 19, 2012, 10:56:44 AM »
Correct me if I am wrong but if I set up my contribution to max out and due to bonus income I max before the end of the year then I will not receive any more employer contribution?  Thus leaving "free" money on the table.  Yes? No?
Unless your plan requires that your employer get even with you at the end of the year if it under-contributed. You should get your plan's details or talk to HR and see if your plan has such a provision.

bogart

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Re: Optimizing 401k contribution
« Reply #6 on: July 19, 2012, 10:59:56 AM »
Correct me if I am wrong but if I set up my contribution to max out and due to bonus income I max before the end of the year then I will not receive any more employer contribution?  Thus leaving "free" money on the table.  Yes? No?

Possibly, depends on your employer's formula for matching.  Mine matches 10% of my salary providing that I contribute at least 3% of my salary in any given month (yes, really).  So $0 is a dumb contribution rate for me, but even fairly small amounts get me the match, and going over those small amounts doesn't increase the match.

My employer's formula isn't typical, but yours may not be either. 

AnnaD

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Re: Optimizing 401k contribution
« Reply #7 on: July 19, 2012, 11:09:56 AM »
Ok I shot an email off to the Finance Lady as I didn't see anything specifically pertaining to undermatched contributions in our 401k Plan Description.
As of right now they match 100% up to 4%.  I think this general set-up is fairly standard.  At no time would I contribute less than 4% so I don't anticipate losing the matched contribution on that end. 

bogart

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Re: Optimizing 401k contribution
« Reply #8 on: July 19, 2012, 11:26:15 AM »
Ok I shot an email off to the Finance Lady as I didn't see anything specifically pertaining to undermatched contributions in our 401k Plan Description.
As of right now they match 100% up to 4%.  I think this general set-up is fairly standard.  At no time would I contribute less than 4% so I don't anticipate losing the matched contribution on that end.

Sounds good.  Yeah, the only trick would be not to front-load so much (or so little) as to lose the 4% -- shouldn't be too hard to avoid!

skyrefuge

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Re: Optimizing 401k contribution
« Reply #9 on: July 19, 2012, 02:19:14 PM »
Sounds good.  Yeah, the only trick would be not to front-load so much (or so little) as to lose the 4% -- shouldn't be too hard to avoid!

Actually, it *is* pretty hard to avoid leaving something on the table in Anna's situation.  Say her base salary is $85k/year ($7083/month).  If she contributes 20% of her monthly paycheck ($1417) every month to her 401(k), and gets no bonuses, then she'll contribute exactly the maximum of $17k ($1417*12 = $17k) by the end of the year.  Meanwhile, her employer will multiply her monthly paycheck by 4% ($7083*.04 = $283) and add that extra $283 to her account each month, for a total match of $3400 ($85k * .04 = $283 * 12 = $3400) over the course of the year.

But say Anna gets a $7k bonus in October.   Her total October paycheck will be $14k, and since her 401(k) automatically sucks in 20% of her paycheck, she'll contribute $2834 in October instead of $1417, which means that she'll hit the $17k max a month earlier and be unable to contribute anything for December.  She'll also get twice the match ($566) in October, so even though she doesn't get any match in the last month, her total match for the year is still $3400.

The problem is that her total income, including the bonus, was now $92k instead of $85k, so the total match available to her was actually $3683 ($92k * .04).  If she knew that at the beginning of the year, then she would have elected to contribute only 18.5% per month instead of 20% because then she would have been able to make 12 contributions instead of 11, and thus gotten 12 matches of $306 (=$3683) instead of 10 of $283 and 1 of $566 (=$3400).  That leaves $283 on the table.

Alternatively, if she selects an 18.5% contribution expecting a $7k bonus, but the bonus never materializes, then she'll end up contributing only $15725 ($85k * .185), leaving her $1275 short of the $17k limit.  That $1275 isn't "lost" like the $283 is, but it's taxed, and loses $319 to the taxman (federal only at 25%, not including state/local).

There are two solutions that 401(k) plans can provide to avoid this issue.  The simpler one is what velocistar suggested, which is to allow you to specify a dollar amount of each paycheck to be contributed rather than a percentage.  In that case, you just say "$17k max divided by 12 months = $1417/month".  That guarantees you'll hit the $17k max, and also that a full 4% of your total yearly income will be contributed as a match, no matter what your yearly income ends up being.

The other option is to do a "true-up" (and that seems to be the accepted term-of-art.  "catch-up" refers to something different, the contributions over $17k that over-50s are allowed to make).  In that case, your company would say "oh, she made $92k and maxed out her contributions last year, but we only matched $3400, so here's an extra $283 to make up for it".

If your plan provides neither of these things, then there's a good chance you'll end up leaving money on the table somewhere.  This particular example suggests it might be slightly better to under-contribute and maximize your match than to over-contribute and lose the match, but you'd have to work out the numbers precisely to know for sure.

Also, it might be worth asking your Finance Lady to look into modifying the 401(k) plan.  After reading the FAQ for eBay employees when their plan added true-up contributions, I got the feeling that these situations aren't part of some malicious scheme to screw employees out of matching funds (how many people actually hit the $17k limit early anyway?); rather, it's just a non-obvious mathematical quirk that no one really thought about when designing the plans.  So I'd guess inertia would be the only thing you have to overcome to get it changed.
« Last Edit: July 19, 2012, 02:23:06 PM by skyrefuge »

grantmeaname

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Re: Optimizing 401k contribution
« Reply #10 on: July 19, 2012, 02:36:24 PM »
The other option is to do a "true-up" (and that seems to be the accepted term-of-art.  "catch-up" refers to something different, the contributions over $17k that over-50s are allowed to make).
Duly noted. I can see how catch-up isn't a great term for the employer's end of the year contributions.

velocistar237

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Re: Optimizing 401k contribution
« Reply #11 on: July 19, 2012, 02:58:27 PM »
AnnaD, are you sure there is a 401k deduction from your bonus? When I've gotten a bonus, the only deductions have been taxes.

AnnaD

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Re: Optimizing 401k contribution
« Reply #12 on: July 19, 2012, 03:08:39 PM »
Skyrefuge - Thanks for laying out the particulars of why maxing too early would leave money on the table.  I will ask about a "true-up" as this is definitely not listed in my 401k Plan Description. 

Velocistar237 - I double checked my paystub and my 401k contribution is definitely deducted.  Taxes are definitely deducted too!

As Skyrefuge points out I may have to forgo the max contribution in order to keep the employer match.  As I mentioned earlier I could put the scraps into a traditional IRA and claim this on my taxes.  Unless someone has another solution?

grantmeaname

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Re: Optimizing 401k contribution
« Reply #13 on: July 19, 2012, 03:14:30 PM »
If you already max out your Roth IRA, you can't also contribute to a traditional IRA. So if you're already putting the full $5000 into your Roth IRA, you'd have to put the scraps into a traditional brokerage account.

AnnaD

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Re: Optimizing 401k contribution
« Reply #14 on: July 19, 2012, 03:40:27 PM »
grantmeaname - You are right :(  Shoot, I don't know how that escaped me. 

bogart

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Re: Optimizing 401k contribution
« Reply #15 on: July 19, 2012, 07:59:11 PM »
Actually, it *is* pretty hard to avoid leaving something on the table in Anna's situation. 

Duh.  Sorry, yes, of course, you're right.  Palm ---> face.