Should I Max Out My 401(k) Early in the Year?

I typically max my 401(k) out each year and I think I could actually do it much earlier in the year if I changed my contributions. Is this a good idea?

Scott

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Hey Scott,

Congratulations on being able to max out your 401(k)! We encourage people to take advantage of their employer-sponsored retirement plan with the ultimate goal of maxing it out at some point in the future. What we haven’t discussed (to my knowledge) is the timing of doing that.

I appreciate the fact that you’re confident you could accelerate the funding of your 401(k) to max it out earlier in the year. This means you’ve got plenty of margin in your month-to-month financial life and you aren’t dependent on every penny that makes it into your checking account. And, as tempting as it is to say “nice job”, give you a digital high-five, and tell you to go for it, there’s one consideration for us to discuss:

How much do you like free money?

If you accelerate the funding of your 401(k) and max it out early in the year, you might miss out on some of the matching contributions that your employer (probably) offers. Why do I say “might”? The following scenario will be dictated by how the 401(k) plan document is written. I can’t promise what you’re about to read applies to you, but it certainly could. Some companies have their 401(k) set up to accommodate this very scenario. Others don’t. It’s important that you know for sure what to expect if you plan on maxing out your contributions. I encourage you to do a bit of research on the plan document to see how your plan works. Or, a simple question to HR may clear things up for you, too. Either way, find out.

Back to business.

Let's say that you get paid every two weeks, or 26 times per year. The contribution limit for 401(k)’s in 2020 is $19,500.

So, if you wanted to max out your contributions over the entire year, you’ll contribute $750 per pay period ($19,500 / 26 = $750).

We’ll also say that your employer makes a dollar-for-dollar 4% matching contribution to your 401(k) and that you earn $100,000 per year (to make it easier to follow). With this info we know that your employer is contributing nearly $154 per pay period on your behalf ($100,000 x 4% = $4,000 and $4,000 / 26 pay periods = $154).

Therefore, you’re able to capture the entire $4,000 employer match over the course of the year meaning the total contribution to your 401(k) would be $23,500 ($19,500 + $4,000).

However, if you were to contribute $1,500 per check you will max out your contributions for the year after only 13 pay periods.

Under certain plan documents, this will cost you money.

In this case, your employer will still match your contributions, but at the same rate as they did in the previous example, or $154 per check throughout the year. Once you’ve maxed out your contributions, the employer matching contributions stop, too. You’ll only receive about $2,000 and forfeit the other $2,000.

If you find yourself in this situation, does that make accelerating the funding of your 401(k) a bad idea? Not necessarily, but I’d encourage you to not be too extreme. Capture most of the employer match if you can and be aware of what you’re giving up. If you decide that you want to get your money into the market as soon as you effectively can by maxing out your 401(k) early, that’s a legitimate strategy and most of the time you’ll be better off for it in the long term. But, if you value that sweet free money your employer contributes to your account, make sure you’re on track to max out your contributions over the entire year.