Getting The Most From Employer-Matching 401(k)s

Avoid This Mistake or Miss Out on Free Money

Getting The Most From Employer-Matching 401(k)s
March 8, 2016

If you are fortunate enough to have an employer-matching 401(k) program at your workplace, you should take advantage of it to the full extent possible. Whether it is a dollar-for-dollar match or a lesser percentage, this is free money from your perspective – and tax-deferred free money on top of that.

However, you do have to be careful in one aspect. There are limits on 401(k) contributions and matching contributions to consider, and if you surpass a limit, you may end up costing yourself potential matching money from your employer.

  • Salary Deferral – You can put aside a maximum of $18,000 in salary for 2016 toward your 401(k), and you can add another $6,000 in catch-up contributions if you are aged 50 years or older.

With greater monthly contributions, you have to be careful as you approach the $18,000 contribution limit. If you reach your employee contribution limit early in the year, you miss the opportunity for matching funds later in the year.

For example, let’s assume you make $200,000 and have a dollar-for-dollar match up to 5% of income. If you contributed $3,000 each month, you would hit the $18,000 limit in six months. Instead of receiving $10,000 in employer-matching contributions, you would only receive the match for six months’ worth of contributions, or $5,000. Your 401(k) would be up $23,000 for the year.

If you instead contributed $1,500 per month to your 401(k), you would have $18,000 in employee contributions and $10,000 in matching contributions for a yearly total of $28,000 – and you would also have an extra $1,500 in taxable take-home pay each month.

For the same reason, bonuses applied toward your 401(k) can be problematic if they are paid early in the year. You have to rebalance your remaining contributions throughout the year to stay below the $18,000 limit.

Some 401(k) plans have a “true-up” provision, which allows the employer to take into account your salary throughout the year (not just in your contributing months) and add back the employer match. Check your plan to see if this provision is included.

  • Total Compensation Limits – Matching compensation plans are set up to reach within some percentage limit of compensation (5% is not uncommon). However, the limit on total annual compensation to be included in the matching calculations is $265,000 in 2016.

If your compensation is $400,000 and you have a dollar-for-dollar matching plan up to 5% of compensation, the maximum employer contribution would be $13,250 (5% of $265,000) instead of $20,000 (5% of $400,000).

Check the language of your 401(k) plan carefully. If salary deferrals are based on the first $265,000 in compensation (“first” being the key word), once you reach the $265,000 mark you cannot contribute any more to the plan for the year – even if you have not reached the $18,000 employee contribution limit yet. This is not common in plans, but it is a clause of which you should be aware.

  • Total Contributions – The overall limit for contributions from employers and employees combined is $53,000 for 2016. If your salary is below that mark, the limit is 100% of your total salary. Catch-up contributions are not included in this total.

Most people will have no trouble staying below this limit, but for jobs with large 401(k) bonuses, this can be an issue.

Keep an eye on those matching limits, spread your contributions throughout the year, and make the most of your pot of "free" money.

Let the free MoneyTips Retirement Planner help you calculate when you can retire without jeopardizing your lifestyle.

Photo © YinYang

  Conversation   |   23 Comments

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Erin | 10.19.15 @ 16:01
Wonderful information. I will be passing this along to several people.
Carla | 10.19.15 @ 16:01
Nice breakdown of the 401(k) options. Thank you!
Steffanie | 10.19.15 @ 16:01
Great information I can share with my kids as my husband is self employed.
Nancy | 10.19.15 @ 16:02
Now, to find an employer who offers benefits like this these days. If I do, I'll keep these tips in mind.
Bobbie | 10.19.15 @ 16:03
I know hubby is maxed out with his, and I've told my daughter to set hers up to max as soon as possible
Daniel | 10.19.15 @ 16:04
40(1k)'s I feel are often the first plan for retirement many people use and any information to ensure you are getting the most out of it is great
Chrisitna | 10.19.15 @ 16:06
Very helpful breakdown - great information!
Kathryn | 10.19.15 @ 16:06
I will have to use this for myself and even give this info to my parents! My dad lost his 401*k) after being fired from his job and having difficulties finding a new one with his disability.
Elaine | 10.19.15 @ 16:07
Didn't know there was a limit. Great info.
Debbie | 10.19.15 @ 16:08
Great info.
Debbie | 10.19.15 @ 16:09
Wish I worked for someone that offered a 401(k)
Britt | 10.19.15 @ 16:10
Ooh. This was a wonderful article with a great breakdown
Angie | 10.19.15 @ 16:10
Hoping I'm able to take advantage of this again when I regain employment!
Kailie | 10.19.15 @ 16:11
I really don't know much about 401(k)s, but this was a great article.
Sarah | 10.19.15 @ 16:12
Hopefully my hubby will one day have a job that offers this. Til then.... good info to hold on to.
Alec | 10.19.15 @ 16:12
I didn't know about this for the 401(k) plans. I'll keep this in mind next year when I rejoin the work force and make sure I read the plan wording carefully so I don't miss out.
Kyle | 10.19.15 @ 16:13
Very useful advise here.
Jo Ann | 10.19.15 @ 16:14
Very useful information especially the part about salary deferral. Great info.
Beverly | 10.19.15 @ 16:14
This is actually quite helpful. Lots of good information here.
Meredith L | 10.19.15 @ 16:17
My husband's company matches up to 6% for the 401(k). It would be ridiculous not to participate because it's like saying no thank you to money!
Ron | 10.19.15 @ 16:17
My previous employer matched my contribution up to 4%. My new employer only wants me to contribute. That was a shock to the system.
Owen | 10.19.15 @ 16:17
Good info to pass.
Andrea | 10.19.15 @ 20:25
Thank you for the info.
$commenter.renderDisplayableName() | 01.27.21 @ 01:41