Contributing to your 401k may not be the most glamorous topic in the investing world, but it is vital that you take advantage of this savings vehicle. Managed properly, the ability to set aside tax-deferred dollars to invest for your retirement will make an enormous contribution toward achieving your goals in the future while simultaneously reducing your present tax liability. These benefits are enough to do a write-up in-and-of themselves, but for today, I’d like to focus on a few simple aspects of your 401k contributions that you should consider each year.
Employer Match
First and foremost, if your employer offers any level of match to your contributions, you MUST at least contribute the amount necessary to receive the maximum matching contribution. Even if your budget runs thin at times, contributing anything less than the minimum amount to receive the full match is a mistake. Employer matching contributions are as close to “free money” as you are ever going to get. Never turn that down for the sake of padding your checking account with a few more dollars from each paycheck.
Annual Contribution Limit
It is possible to over-fund tax-deferred (401ks, IRAs, etc.) savings, but only in the most extreme circumstances. If you are concerned about that possibility, you should seek counsel from your financial advisor to evaluate your situation. Assuming that you have addressed that potential issue, you should contribute every dollar you can to tax-deferred accounts.
For 2021 you can contribute (and deduct from income) as much as $19,500 to your 401k account. Furthermore, employer contributions (which are not tax-deductible to you) are allowed up to an additional $32,000. These amounts are often increased from year to year to match inflation – consequently, you should verify the maximum allowable contributions on an annual basis.
Catch-Up Contribution
For those age 50 and older, the IRS also allows what is called a catch-up contribution. This contribution offers people nearing retirement age (or at least retirement planning) the flexibility to “turbo-charge” their tax-deferred retirement savings.
For 2021, the catch-up contribution limit is an additional $6,500 beyond the standard limit – or $26,000 in total employee contributions (all of which are tax-deductible).
Don’t Let Contributions Be Cut Early
This one is a bit rare, but I have encountered it with clients over the years. There is a maximum amount of compensation for highly compensated individuals that is allowed for the calculation of their allocated employer contributions.
For 2021, this threshold is $290,000 – a figure that is also indexed annually for inflation.
While this rule has a number of intricacies that, quite frankly, are of little interest or importance to the employee, it can play a unique factor in how your employer executes your 401k paycheck contributions.
In rare cases, some employers will not allow contributions to the 401k plan once the “Maximum Eligible Compensation Limit has been reached – regardless of whether you have contributed your own maximum amount yet. For example, your contribution percentage may be such that you’ve only contributed $9,000 to your 401k as of June 15th, but if you’ve already received $290,000 in total compensation by that time, the employer may not allow you to make your remaining contributions.
In Summary
Your 401k is a critical resource in planning for retirement. Use it wisely. Take the time each year to review the terms of your employer’s 401k plan as well as changes to regulatory contribution limits. With these factors accounted for, craft a strategy that will maximize total contributions to your account (without placing too great a strain on your current budgetary demands). Even better, engage your financial advisor to do this with you or for you! At Buckhead Capital, we have ample experience in helping individuals evaluate their options and make the best decisions. We are more than happy to help you along the way.
