How To Get 100% Of Your 401(k) Match
Earlier this year we talked about investment options if you're already making the maximum contribution(s) to your 401(k) and still want to save money elsewhere. We also covered the importance of contributing to your employer's 401(k) plan in order to get the full matching contribution…aka compensation.
Today we're talking 401(k) again and I want to show you why it's important to understand how your employer matches your contributions.
I'm pretty confident saying most of us know if our employer makes matching contributions to the 401(k).
I'm not as confident in saying most of us know how the matching contributions work.
One major problem can show up when we don't know how our employer matches our 401(k) contributions. The problem? We might not be getting our full matching compensation, even though we’re contributing enough to get it.
Yup, it's true.
You might not be paying attention so here's me snapping my fingers saying "pay attention" because you could be missing out on compensation that's earmarked for you. And be sure to read to the end where I give you six steps to help you figure out how to get your FULL 401(k) matching compensation.
When it comes to 401(k) matching contributions, some employers make matching contributions based on the amount you contribute each pay period. In this scenario, you could max out your 401(k) over the course of 5 months and receive the full match - because they match based on how much you contribute and run their matching formula that way. The timing of our contribution is not as important as the amount we contribute.
Many employers will only match during pay periods when you're making a contribution to your 401(k). In this scenario, both how much we contribute and when we make our 401(k) contributions determines how much of the matching compensation we could receive.
What does that mean? It means if we aren't careful with how we time our contributions, we could miss out on our full matching compensation.
Confused? No worries, I have a story to tell so let's keep going.
We have two companies, Company A & Company B and both have an excellent 401(k) matching program.
Company A matches $1 for every $1 we contribute, and they match this up to 3% of our salary. They also match $0.50 for every $1 we contribute on the next 2% of our salary. Their matching contributions are spread out over the calendar year, or over 26 pay periods in this example.
Company B has the exact same match. However, they match based on the amount the employee contributes and it doesn't matter if the employee makes his/her contributions over the course of the calendar year, or over 4 months. The match is based on the contribution amount, not how/when the employee makes contributions.
Now let's figure out what the full matching compensation would be. We’ll use an annual salary of $250,000.
In our “dollar for dollar up to 3%” match scenario, $250,000 x 3% = $7500. This is Part 1 of the match.
Part 2 of our match says $0.50 up to the next 2% of our salary, so $250,000 x 2% = $5,000, and $5,000 x 50% = $2,500.
Total match = 4% of our salary.
At $250,000 salary, our full matching compensation = $10,000. This is true for both Company A and Company B.
We know we have to contribute at least $10,000 to receive our full matching compensation. That's important. What's more important is how or when we make those contributions.
It doesn't matter how or when we make our contributions for Company B. We could do it in one lump sum contribution or spread our 401(k) contributions out over the course of the year. For Company B we simply have to contribute at least $10,000 to get the full match in this example. Easy peasy.
Company A is a different story so we're going to focus on Company A. This is where, if we're making 401(k) contributions to at least get the full match, we can leave our "free money" on the table.
Remember, if you work for Company A, you need to spread your 401(k) contributions out over the course of the year in order to receive the full company match. This is because they match only during pay periods when employees make a contribution.
That last sentence is important. Here's why:
Employee #1 works for Company A. She's an aggressive saver and likes to max out her 401(k) as quickly as possible. She contributes 15% of her paycheck to her 401(k) starting January 1. By her 14th pay period, she's already maxed out her 401(k). High five to her for being such an aggressive saver. The downside is she's only received $5384 in matching compensation. We know she's eligible to receive $10,000 in matching compensation. Unfortunately, her aggressive savings habit results in her missing out on nearly 50% of her matching compensation.
Wait, what?
Company A matches employee contributions only during pay periods in which employees make a contribution. If the full match is $10,000 then we divide our full match by the number of pay periods in the calendar year.
Company A has 26 pay periods, so $10,000 / 26 = $384.62
$384.62 is the matching contribution Company A will contribute each pay period.
Since Employee #1 maxed out her 401(k) in just 14 weeks, she received the following matching contributions:
$384.62 x 14 = $5,384.62
If this is us, if we work for Company A, we could literally be leaving $4615.32 (or more) of compensation that's been earmarked for us…on the table.
That's just for one year. If we don't pay attention, this starts to negatively compound and work against us. Over the course of 20 years, we could potentially lose out on nearly $160,000 of additional retirement money (invested at 5%). May not seem like much, but that's more than 60% of Employee #1's annual salary. Raise your hand if you're okay with this happening to you?
Nah, didn't think so.
“But Darren, I like to max out my 401(k) early in the year. Then I take the additional money in my paycheck after I’ve maxed out and use it for [insert financial goal here].”
I hear you. First, great work. Love the fact you’re keeping money on your balance sheet and using it for another financial goal vs consuming it via lifestyle. You can still do that. It simply involves a re-framing or adjustment to your savings plan. If you contribute to your 401(k) over the course of the year to get the full match, you’re still putting away the same amount of money vs. if you max it out earlier in the year. The timing of it is simply different. So use the differential in your paycheck starting on January 1 and automate that savings right away. At the end of the year, you will (assuming you’re diligent about it) have the same amount of money for [insert financial goal here].
Going back to Employee #1, she should contribute $19,500 (the maximum amount for 2020) over the course of the year. To make this happen, she simply adjusts the percentage of her 401(k) contributions so they’re spread out over 26 pay periods. Instead of 15% for 14 pay periods, she should contribute 8% of her salary for 21 pay periods and 7% for the rest of the year.* She still contributes the same $19,500 and she gets 100% of her matching compensation - an additional $4615. Over time, we know this adds up.
If Employee #1 is also saving for [insert financial goal here], she can…wait, no. She should adjust her automatic savings to grab the difference in her paycheck (the amount between 15% and 8%/7%) when she gets paid every two weeks.
#winning
If you're entitled to matching compensation via your employer's 401(k) plan, do yourself a favor. Set aside some time to be 100% certain you're receiving 100% of your matching compensation. This is a smart use of Money Value of Time.
How To Get Your FULL 401(k) Matching Compensation
Understand how your company matches your 401(k) contributions - are they like Company A or Company B?
Use your company's formula to determine what your full match would be:
If you work for Company B, easy peasy - contribute at least enough to get the full match over the period of time that works best for you. You can skip Steps 3-6.
If you work for Company A, keep reading.
Using a recent paystub, a recent 401(k) statement, or even in your 401(k) provider's website, your contributions and your employer's contributions should be separated somewhere in the paycheck, statement, or online. This tells you how much your employer "matched" year to date, last year, etc.
Compare your numbers from #2 and #3 above.
If they don't match up, then it's time to do some research.
Not sure how to figure it out on your own? Reach out to your Human Resources Department or a fee-only financial advisor and they can help you.
*some 401(k) providers only allow you to contribute in whole percentages; if you can contribute dollar amounts, you might not have to adjust your contribution amounts.