I ask almost everyone that comes into our office for financial counseling if they are “maxing” their company’s 401(k) plan. The answer is usually a proud “yes”. If you think you are investing as much as legally possible, it might help to review the laws around what you can actually invest each year. Chances are that you are not taking full advantage of your 401(k).
You are allowed up to four different types of contributions into your 401(k). You have what I will call your basic contribution, a catch up contribution, a company match and then potentially after-tax contributions. Let’s break down all four types to see if you are in fact maxing out your plan.
- Basic Contribution: In 2017, assuming you make more money than the contribution limit itself, you are allowed up to an $18,000 basic contribution. This investment may be directed toward your pre-tax account or, if you have the option, into your after-tax Roth account. You can also split your contributions so that some goes into each, but they cannot total more than $18,000. Most of you already know about this contribution limit.
- Catch up Contribution: If you are under age 50 you might not know about this one. Employees who turn 50 can add an additional $6,000 to their 401(k) plan. You can direct this extra amount just like the basic contribution…into the pre-tax or Roth portion of your plan. If you are over 50 and are maxing out your plan you now have $24,000 of your own money being invested. Not bad!
- Company Match: This is what helps make our 401(k) plans really hum. If you are lucky enough to work for an employer that matches some of your contribution, you are having additional dollars invested into your account. The company match always goes into your pre-tax portion of your plan. The match formula and your contribution will obviously determine how much money you get matched.
So, to this point you may not have heard anything new. You are most likely doing all three and thinking you are maxing out your plan. Let’s review the fourth way to save into your plan.
- After-Tax: If your plan offers an after-tax option, and most do, once you reach your maximum limits from the first two contribution types, you could be automatically switched over to after-tax contributions. This is the contribution type that most do not take full advantage of. Many people try to balance out their contributions to achieve the maximum contribution with the first two types (basic and catch up contribution) and if they happen to go over they may get a little after-tax money going into the plan. I suggest, if cash flow permits, that you take full advantage of the after-tax option.
Let’s review how much you can actually contribute to your plan. In other words, what is your maximum contribution? In 2017, the IRS states that you can have a total of $54,000 contributed annually to your plan. That is a big number! This number includes the sum of all four contribution types, including the company match. Let’s think about this for a moment. Let’s say you are over 50 and you max out contribution type 1 and 2. That means you added $24,000 to your plan. Let’s also assume that your company matched you a total of $8,000 so that went in as the third type of contribution. That gets you to a total of $32,000 into your plan so far. Based on the IRS max of $54,000, you may be able to add another $22,000 as contribution type 4 into your after-tax portion of your plan.
So are you maxing out your plan? You are if you are getting $54,000 new dollars into your plan each year. Why would you want to always take advantage of this option? One obvious reason is to save more for retirement; however, I will have an even better reason for you next week. Here is a hint: how would you like to be able to add $20,000 plus to a Roth IRA no matter what your income level is? Come back next week for this little known and seldom used tidbit that could help you be better prepared for retirement!