Did you know that how you contribute to your 401k matters when it comes to getting the most money from your employer? You've heard the saying "take advantage of your employer's matching contribution because it's free money", but are you taking advantage of all of it, or are you leaving some on the table?
You'd be surprised, but contributing the right amount of money, at the right time, really does make a difference in making sure that you get all of your matching contribution - and it could end up being over a $1,000 difference (if not more) if you're not careful.
So, if you get an employer match on your 401k, you need to be taking advantage of it! Here's why:
The Most Common Employer Contribution Models
Employers use a wide variety of formulas to calculate the employer 401k contribution. The most common type of match is typically $1.00 per every $1.00 the employee contributes up to a certain percentage (usually 5%). The second most common type of match is $0.50 per every $1.00 contributed, up to a certain percentage.
Some employers get very creative - using tiered levels of contribution amounts. For example, Qualcomm uses this formula: 100% on first $1,500, 50% on the next $1,500, 33% on next $7,500, and 10% thereafter. At the end of the day, the max contribution by Qualcomm if the employee contributes the 2014 maximum of $17,500 is $5,425.
Finally, how some employers pay the match varies as well, and that's important to note. All of our scenarios below are based on equal matching per pay period, which is by far the most common matching program. However, some employers pay the full match on the last pay period of the year - and you're only eligible for the match if you're still employed on that date. This distinction is important because you must be employed on that date or you won't get your matching contribution.
Setting Up The Scenarios
To look at every scenario, we are going to assume the following:
- Employee makes $52,000 per year gross
- Employee will receive a full year of bi-weekly paychecks (26 in total)
- The company matches $1.00 for each $1.00 contributed up to 5% of the employee's gross pay
- The company matches each pay period
We are also using the 2014 401k contribution limits, which is $17,500.
Based on that 5% contribution amount, you might assume that the employee will receive $2,600 in company match no matter what. But the truth is that isn't the case. We looked at 4 different scenarios to see what works and what doesn't:
- The employee contributes 5% each paycheck for the entire year
- The employee tries to front load and max their 401k in the first half of the year, so 13 contributions of 67.3%
- The employee tries to maximize their 401k contribution equally for the entire year, so 26 contributions of 33.65%
- The employee tries to front load their 401k contribution, but still wants the full employer max - an interesting combination of contributions
Scenario #1 - 5% Contribution
This is the most common scenario - an employee simply contributions to the company match each pay period. While it doesn't maximize the 401k contribution potential, it does fully take advantage of the employer match.
Let's look at a breakdown:
As you can see, with this plan, you get the following:
- You Contribute: $2,600
- Your Employer Contributes: $2,600
- Total Annual Contribution Combined: $5,200
Scenario #2 - 67.3% Contribution
But what if you want to front load your contributions? A variation of this plan could be stashing away a bonus - but we run our example through 13 paychecks at 67.3%. This will complete your contributions half way through the year.
Here's what it looks like:
As you can see, with this plan, you end up with the following:
- You contribute: $17,500
- Your employer contributes: $1,300
- Total Annual Contribution Combined: $18,800
While you max your own personal contributions with this plan, it fails because your employer is contributing less that their potential max. Instead of getting $2,600 in employer contributions, you're only getting $1,300. This plan actually costs you $1,300.
Scenario #3 - 33.65% Contribution
What if, instead of front loading your 401k contributions, you calculated out the exact amount you needed to max your 401k contribution? In our current example, that would be 33.65% per paycheck for the entire year.
Here's what that looks like:
Under this scenario, you end up with the following:
- You contribute: $17,500
- Your employer contributes: $2,600
- Total Annual Contribution Combined: $20,100
This plan gets you the max on both fronts - you contribute the annual maximum personally, and it also allows you to take advantage of your employer's maximum contribution as well.
Scenario #4 - 75% Contribution
But what if you really want to front load? You still can, but it gets really tricky. Here's what the math looks like to make it work:
As you can see, you start with a 75% contribution, then you need to do 50% for one week, then 5% to the end. This gets you the same result as in Scenario #3, but it allows you to front load more.
I want to touch on two other issues that could arise and are semi-common. First, if your employer matches in a lump sum, none of this matters. Contribute the maximum personally (using the contribution from Scenario #3), and simply make sure you're employed on the final payday. This will make sure that you get the full match.
Second, it's really, really hard to get your contribution perfect since you have to use percentages and not dollar amounts. I want to remind you to get it as close as you can, but shoot over, not under. If you shoot over (by just a little), your employer simply will cap you on your last paycheck. However, if you shoot under too much, you risk missing your match on that last paycheck, which could leave a little money on the table.
What If You Can't Afford Your Full 401k Match?
A big question I get all the time is, "what if you can't afford your 401k match?"
Well, first off, you have to remember that when you contribute to your 401k, you're also lowering your taxable income. As such, contributing a small amount like 5% will likely not change your net take-home pay very much, since you're also paying less taxes as a result.
Second, there are tools and services like LendTable that will advance you the money needed for you to take advantage of your full employer match, and you pay them a service fee. While it does cost money, they only make money if you make money - so it can be a big win.
So while it may seem intuitive that your company simply matches a given percentage, if you're not careful with how you personally elect your contributions, you could be leaving money on the table.
Make sure that you take full advantage of your employer's 401k match, and don't let your own choices mess that up.
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.