Maxing out your 401K too early every year can cost you over a million dollars!


Your 401K is often your biggest retirement nest egg, and maxing it out is a fantastic way to boost your retirement savings, however many people make very costly mistakes when trying to save for retirement.

The mistake that we will discuss today primarily affects people who have very good income, as well as good 401K match programs from their employers.  In my example, Mr. X will make $120,000/year salary, and he is going to get a $40,000 bonus in 2014, for a total 2014 income of $160,000, and his company matches 7% on his 401K contributions.  Mr. X always tries to max out his 401K as early in the year as possible, so that he can enjoy larger paychecks at the end of the year (because once you hit the 401K maximum, your total net pay goes way up due to that deduction stopping in your monthly paychecks).  In 2014, Mr. X decides that he will put 25% of his April bonus into the 401K and 15% of each paycheck into his 401K until he hits the maximum contribution level ($17,500/year).

After 5 months, Mr. X has invested $17,500 into his 401K, maxing out his annual contribution, and he enjoys much higher take-home pay for the next 7 months.

Congratulations Mr. X, you just cost yourself almost $5,000 in free money…

In a more severe example, where Mr. X makes $180,000/year salary, and gets a $70,000 bonus, he would have cost himself over $9,000 in free money…

How does this happen?

Well, in this case, Mr. X’s company matches the first 7% that he contributes from each paycheck.  However, his company no longer has to match once he hits the maximum contribution, therefore when he hit his maximum contribution after 5 months (in the first scenario), the company matched the first 7% of those 5 paychecks (and the bonus), but the company did not match anything in the last 7 months of the year.  Had he just put in 11% of his paychecks and bonus, instead of front-loading the contributions, he would have received an additional $4,900 in company contributions.  In the more severe example, let’s say that Mr. X lost $9,000/year in free money for 10 straight years between age 35 and 44, his 401K would end up being over $1,000,000 lower as a result when he retires.  So, we are not talking about chump change here…

The moral of this story is that maxing out your 401K is good, but maxing out your company contribution is even more important.  Your company is offering you (and your family) free money, so please make sure to spend a few extra minutes this year determining what percentage you should contribute so that you maximize your company’s match each month, and on your annual bonus, while hitting the maximum contribution at the very end of the year.  Your kids, and grandkids, will thank you for the extra million dollars decades from now…

 

NOTE:  Some companies DO provide catch-up contributions in these situations.  These rules are company and plan-specific, so it is always good to either check with the 401K provider, or check your final paycheck of the year to confirm that you got the catch-up contribution before assuming that you did.  It is worth noting that companies can change providers, or rules inside the 401K, at will. So, my advice would be to check the status of that rule each year prior to setting up your contribution strategy for the year.

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About Todd Hagopian (@ToddHagopian)

Todd Hagopian received his BA from Eastern Michigan University with a major in Political Science. After graduation, he worked as a Financial Advisor and a Bank Manager before returning to school. He attended Michigan State University, where he completed an MBA with a double-major in Finance and Marketing. Todd is now a Senior Product Development Manager for a Fortune 500 company. He frequently writes about business issues, social media strategy, and political issues that he finds important. Enjoy the blog!

Posted on January 17, 2014, in Investing and tagged , , , , , , , , . Bookmark the permalink. 1 Comment.

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