Are You Leaving Free Retirement Money On The Table?
One of the retirement savings strategies of many high-income earners is to max out the amount they can contribute to their employer-sponsored retirement account, which for those under age 50 is capped at $18,000 for 2017. Some people try to reach their contribution limit early in the year to earn maximum returns on their investments. This can be a smart approach, but it can also be a mistake. The determining factor is whether your employer makes matching contributions on paycheck-by-paycheck basis instead of on an annualized basis.
If your employer only contributes matching funds during pay periods in which you make contributions, maxing out early can result in a significant reduction in the amount you receive. If you over-contribute and reach your annual limit in June, you will only receive half of the match your employer offers because you aren't contributing for the second half of the year, so they aren't making any matching contributions.
For example, Jane is 39 years old and makes $360,000 per year working at Surgeons R Us. She thinks it is a great idea to contribute 10% of each paycheck to her 401k since her employer does a 5% match. But at the end of June, Jane has reached her $18,000 limit, so by law, her employer must stop deducting contributions from her paycheck. Since Surgeons R Us matches employee contributions on a paycheck-by-paycheck basis, they must also stop making their 5% matching contributions for the rest of the year. If Jane had chosen to contribute only 5% of her income, she would have been able to contribute all year and thus received an additional $9,000 in employer matching funds.
If you are maxing out your retirement plan contributions, make sure you understand how your employer's plan is structured and how the amount you contribute – and when – affects the matching funds you will receive. If you don't, you could be leaving money on the table.