“In the long run, it’s not just how much money you make that will determine your future prosperity. It’s how much of that money you put to work by saving it and investing it.”
– Peter Lynch
Think you’re maxing out your 401(k)?
I ask this question to almost everyone that comes into our office for financial guidance. Inevitably, they all proudly answer “Yes!”
Chances are, you’re probably thinking the same thing. But guess what?
Chances are, you’re not actually maxing out your 401(k).
Here’s the thing. The IRS allows you to contribute a lot of money to your 401(k) plan, through a lot of different channels. But most people are only aware of one or two of these channels.
If you’re contributing the maximum amount through those channels, that’s great. But you aren’t hitting the absolute max.
There are four different types of contributions you can make into your 401(k):
• Basic contribution
• Company match
• Catch-up contribution
• After-tax contribution
Let’s break down all four types to see if you are, in fact, maxing out your plan.
- Basic Contribution
In 2018, you’re allowed a basic contribution to your 401(k) totaling up to $18,500. This is also known as an elective deferral.
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 $18,500.
Most people already know about this contribution limit. But even then, few people contribute enough to reach this preliminary limit.
According to Vanguard, the average 401(k) contribution is just 6.2%, and less than 20% of participants contribute more than 10%. At that average rate, you would have to make nearly $300k to reach the basic contribution limit!
So start with the basics. Contribute as much as you can up to the basic contribution limit, even if it’s challenging. Luckily for you, the next item on our list is so easy to get, it’s practically free money.
- Company Match
This is what helps make our 401(k) plans really hum. It’s like Miracle-Gro for your money.
If you are lucky enough to work for an employer that matches some of your contributions, you are having additional dollars invested into your account.
The company match always goes into the pre-tax portion of your plan. The match formula and your contribution will obviously determine how much money you get matched.
The most common 401(k) match formula is 50 cents on the dollar, up to a 6% contribution. That means that if you are contributing at least 6% (which on average, most of us are) than the employer will kick in 3%. Some employers will even go dollar-for-dollar, matching every cent you contribute up to a certain limit.
Imagine saving an additional 50%, or even 100%, tax-deferred! That’s a powerful boost no matter your contribution level. Don’t underestimate the power—and simplicity—of a company matched contribution.
- Catch-up Contribution
If you’re over the age of 50, pay attention.
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.
So if you are over 50 and are maxing out your plan, you now have $24,500 of your own money being invested.
Add in the company match, and depending your income level, you could be looking at anywhere from $30,000 to $50,000 being saved to your 401(k) every year.
Unfortunately, even fewer people take advantage of this contribution type. According to that same Vanguard survey, only around 15% of plan participants make catch-up contributions. This is a crucial factor to maxing your 401(k)—take advantage of it!
But then again, maybe you already do.
Maybe, up to this point, you haven’t heard anything new. You’re taking advantage of all three contributions types and are feeling pretty proud of yourself—you’re maxing out your plan!
Well, let’s review the fourth and final way to save into your plan, just to make sure…
- After-Tax Contribution
If your plan offers an after-tax option (and many do), once you reach your maximum limits from the basic and catch-up contributions, you could be automatically switched over to after-tax contributions.
This is the least utilized contribution type of all, and most who do know about it still aren’t taking full advantage.
Many people try to balance out their contributions to achieve the maximum contribution with the basic and catch-up contribution, and if they happen to go over, they may get a little after-tax money going into the plan.
However, I suggest that if cash flow permits, that you boost your contributions to this part of the account.
How is this possible?
Because the limit isn’t actually the limit.
In 2018, the IRS states that you can have a total of $55,000 contributed annually to your plan. That’s a big number! This number includes the sum of pre-tax, Roth, and after-tax contributions.
Let’s think about this for a moment. Let’s say you are over 50 and you max out your basic contribution. That means you added $18,500 to your plan.
Let’s also assume that your company matched you a total of $8,000. That went in as the second type of contribution. That gets you to a total of $26,500 into your plan so far. Based on the IRS max of $55,000, you may be able to add another $28,500 as contribution type 4 into your after-tax portion of your plan.
And don’t forget your catch-up (type 3). That’s pre-tax, too, and another $6,000. This brings your grand total of all monies going into your retirement plan…
To a whopping $61,000!
“If we command our wealth, we shall be rich and free. If our wealth commands us, we are poor indeed.”
– Edmund Burke
So: are you maxing out your plan? If you’re over 50 and not getting $61,000 new dollars into your plan each year, then probably not.
Why would you want to always take advantage of these options, especially the after-tax contributions? One obvious reason is to save more for retirement. But that’s not all—and next week I’ll have an even better reason to share with you. What is ?
Here’s a hint: how would you like to be able to add as much as $36,500 to a Roth IRA…no matter what your income level is?
Check the blog next week for this little-known and seldom used tidbit that could help you be better prepared for retirement!
Are you Retirement Ready? Take the QUIZ here to find out. Byron W. Ellis, CFP®, CLU®, ChFC®, CRPC®, is a CERTIFIED FINANCIAL PLANNER™ professional and Managing Director United Capital Financial Advisers, LLC, a Financial Life Management firm. The information contained in this article is intended for information only is not a recommendation, and should not be considered investment advice. Investing involves risk including the possible loss of principal. Please contact your financial advisor with questions about your specific needs and circumstances. © Byron Ellis