Maxing Out a 401(k) Plan Too Early

Disclosure: This article will most likely apply to high-income earners or those that are financially healthy and extremely aggressive savers. Let me just start off with mentioning that if you are maxing out your Roth IRA & 401(k) year in and year out, this is a great choice for your future as long as other financial factors allow you to do so. A quick reminder on current (2021) contribution limits for these two accounts are as follows:

  1. Roth IRA - $6,000/year (under age 50), $7,000/year (age 50 or older)
  2. 401(k) Pre-Tax/Roth - $19,500/year (under age 50), $26,000 (age 50 or older)

 

Despite this generally being thought of as a great move, if you’re able, you could be making a huge mistake if you are TOO eager to max out your 401(k) in any given year. This is assuming that you will receive a specific kind of employer match. Note: The following information will not apply to someone who, for example, gets a “50 cents-on-the-dollar match” up to the annual limit from his/her employer. No matter how quickly into any given year you hit the annual limit of $19,500 (< 50 years old) or $26,000 (> 50 years old), you should see the full match potential regardless from your employer. Disregarding this possibility, let’s look at a hypothetical example below:

David, age 51, earns a salary of $216,600/year (or $18,055/month). He has no debt. He has access to a 401(k) at his place of employment. David gets a full dollar-for-dollar match on the first 3% of his income that he contributes, and 50 cents-on-the-dollar for the next 2% of income he contributes. Therefore, if he just simply contributes 5% of income to his 401(k) plan, the employer will match 4% of David’s annual salary, of $216,600, into the plan on his behalf. Free money! Being goal-oriented, David simply decides that he wants to max out his 401(k) half-way through the year. He is will contribute 24% of his annual income. Since he maxed out the IRS annual limit of $26,000 by the end of June, he won’t be able to contribute for the 2nd half of the year.  Consequently, he will be leaving FREE MONEY on the table. This is a rare example of how being goal-oriented can hurt you.

Key TakeAways:

  • If 24% of his income is contributed, the total employer match for the year will be roughly $4,333, only 2% of David’s income. (Full match potential is 4%.)
  • In a 2nd scenario, if 12% of his income is contributed, the total employer match for the year will be roughly $8,666. (Full match potential.)

 

 

Author: Griffin Lusk, Financial Advisor

Source: High Earners: Maximize Your 401(k) Match
 

 

Whitaker-Myers Wealth Managers, LTD is a registered investment adviser.  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, investments, or investment strategies.  Investments involve risk and unless otherwise stated, are not guaranteed.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.