Help a Reader: Maxing Out after Reaching 401k Limit

Here's an email I recently received from a reader:

Some background info: My baseline gross salary is $74k, but with recent overtime it's looking like I'm on pace to make closer to $85k this year. I've been contributing 30% pre-tax dollars to my company 401k plan. They match 50% up to the first 8% I contribute, so basically I get a free 4%.

On my previous pay period, I hit my max $17,500 pre-tax contribution limit. In that same pay period, there was also a new line item for after-tax contribution spillover, so now I have $280 of after-tax money in my account.

My max employer match is 4% if I put in 8%. I just called my benefits office and they clarified this is applicable to both pre-tax AND after-tax contributions to the retirement account.

I'm 25 years old and don't have a Roth IRA setup yet.

My question is: Should I contribute 8% of my after-tax dollars to my retirement plan so I can get the 4% match from my company? Should I start/max out a Roth IRA? Should I do some combination of both? Any other recommendations?

What's your advice for him?

Comments

[Steve]

That sounds weird the after tax gets matched as well but if it does then you can't beat it. There's no tax benefit out there thats worth turning down an immediate 50% return on your money.

Anything you can get into a Roth at this point would be nice given, especially after the large 401k contributions you are making, your tax bracket must be nice and low, and having roth accounts to go with your 401k will help later for managing tax bills when you start taking the money out. But once again only after you take all the employer matching you can get a hold of!

[Steve]

25? Man this guy is gonna be wealthy.

[Mike H]

Normally I'd say keep taking the match from your employer. Any surplus savings you can put into a Roth IRA.

However I can't get the math to work out here... if you are contributing 8% and are on track to make $85K as of this year (so this would imply that you are already $65K of the way there), how can you be exceeding $17.5K? 8% of 85K is $7K and your employer match would be $3.5K. Something doesn't seem to add up here.

Well done on your savings!

-Mike

[getagrip]

"They match 50% up to the first 8% I contribute..."

So 8% of $85K (max salary) = $6800 so the company will at most match with $3400, regardless of how much more money is put into the 401K this is the way it's typically done. If the company is paying 50% on everything you put into the 401K, then more to the 401K makes sense. However I've got some concerns with this and don't think that is what the company is necessarily doing.

Generally, the advice is put into your employer account to gain the match, that would be around $6800 in this case. Then put the rest into your own IRA (Roth is typically recommended) to the tune of $5500. Then put the rest up to the limit into your 401K, or $10,700, for the total of $17,500 (plus the $3400 match for $20,900) in the 401K and $5500 in personal IRA. From there the rest of your savings would be taxable and could be placed into any kind of savings or investment vehicle.

So now I come to wondering about the "after tax" money into the "401K" account. Last I heard, I thought this was not allowed, as in once you cap out at $17,500 the money will not be placed in a retirement fund. Where I work they simply don't take any more money into the fund, you're cut off. If they are still collecting it, I suspect it is being placed in a separate taxable account in your name. That's not a horrible thing, but don't think that money is going to grow tax defered or tax free or is considered part of your retirement money. It's basically taxable savings under the company that is also handling the 401K and you may or may not want to be investing that money with them.

Best of luck.

[Erik]

I have never heard of after tax money going into a 401k so you should really check into that. However, my point here will want you to rethink it anyway.

Companies that match 50% of the first X% are committed a fixed maximum dollar amount based on your salary. As getagrip points out, the company will put in $3,400 if you contribute at least $6,800. They are not going to put in any more money no matter how much you contribute. The extra money that you talk about putting into the after tax 401k will not yield a 50% return as you have already hit the maximum. (Note based on your very large 30% contribution, and maxing out in a smaller number of periods you may not have achieved the full max based on the way the company may pay into the account. Even if that is right, most companies will make a true up payment near the end of the year to correct this. If they don't you could talk to HR and show them that you didn't get your $3,400 but you put in more than enough to reach that amount.)

Second point is that putting in 30% doesn't make sense. I'd suggest you change your percentage to just over the maximum so you can hit it in your last pay period and even out your monthly finances and budget. In this case, I'd set your percentage to 21% to max out the annual limit.

[DCS]

He wasn't contributing 8% before, he was contributing 30%. That's how he hit the limit. And adjusting the contributions makes sense, but he's not asking about that either - that ship has sailed for this year.

What he's asking is, given that he has already hit the tax-deferral limit, should he reduce his contribution to zero (since it will not be tax-deferred), or should he only reduce it to 8% (which will be contributed post-tax) to capture the available employer match for the rest of the year.

I'm with Steve - even with your contributions and the employer's contributions taxed, that's still no hell of a guaranteed, instant return. And at 25, that's a lot of opportunity benefit over time, even of your post-tax contributions are taxed again on withdrawal (if they are, not sure how that works).

[Tvo]

If I were him, I would double/triple check again on the pre-tax AND after-tax, seems too good to be true. Also is the match 8% of your contribution or 8% of total salary? If you have a maximum value that the company will match (in total) then you have to be cognizant of that value.

If the company match is true and you do have after-tax contribution spillover, then continue the course, getting the match will always be better.

If it is not, then stop contributing into the 401K and start max-ing out a Roth IRA.

[Middle Aged Limey]

It sounds like it does not benefit you to max it out early. The employer match will be 4% a check weather or not it is pre tax or after tax, so why not spread out the contributions over the course of the year to make sure you get a 4% match each check, but also only contribute for the pre tax benefit. Yur last December check hitting the 17.5 in your contributions...I think the difference should go to a Roth, that will give you more flexibility between pulling cash from pre tax and after tax buckets later in life.

[Ed]

Do you know if your 401(k) provides one with the ability to execute an in plan roll-over to an IRA? There are some plans that do so you may want to double check on it.
If they do, I would keep plugging away at the post-tax contributions, and then do an in plan rollover at year end to an IRA, then immediately convert to a Roth. Referred to as a mega-backdoor. To the extent your cashflow needs provide you with the ability to contribute a significant amount of money to retirement, this provides a great way to get funds in excess of the ROTH contribution limitation into a ROTH every year. May not be something you want to do now, but may be something to keep in your back pocket to utilize in the future.

[Jason]

what nobody here seems to be considering is the quality of options available in the 401K. The advice I've always heard is that you are best to maximize the match, and then put the max out of the internal 401K given the likelihood you can get better (and lower fee) options from Vanguard or Fidelity.

[jclimber]

Many 401k plans now have options for lower cost Vanguard funds (mine does). Also some have an option where you can move the money to a brokerage account and self-manage it there for a very minimal fee (this is not an IRA, it is still considered part of your 401k as you can move money back and forth with some restrictions).

[Apex]

Unfortunately the OP has mad a mistake but there just might be enough time left in the year to fix it.

The employer matches 4% of the first 8% of your salary. You don't get extra match by putting in after tax contributions. If the OP had timed the contributions so that on the last pay check the amount equaled right at about 17500 then he would receive the full 4% match on his salary and he would have the full 17500 tax deductible contribution in his 401k.

At this point in time in order to get the rest of his match for the year he is going to have to put in these after tax contributions to keep getting the match. The problem is those contributions would be better placed in a Roth IRA because then the gains would be tax free.

However since the OP is comfortable having 30% of his salary put in this account there is just about enough time to fix this. What he should do immediately is drop this percent to 8%. This will still get him the full employer match for the rest of the year. Then he should divert the remaining 22% to a Roth IRA. Based on his current rate he should be able to just about max out the Roth IRA by year end if he opens it immediately. That will get him the most benefit in this situation. Having these funds in the Roth IRA is far more valuable than having them in the after tax portion of his 401-k.

For next year he should consider planning for this earlier to make sure he maxes the Roth IRA before putting any after tax money into the 401-k.

[jclimber]

@Apex - some companies allow you to max your 401k before the end of the year and still give you your full match. This policy varies from company to company so better to check with your HR person.

[Jerry]

What's all the hullabaloo about after tax 401K Contributions?
DCS hit the nail on the head.
The original poster said he was contributing 30% of his salary. Imagine, if he put in $1,000/payday, and on the 18th payment($18,000), there would be $500 more that could NOT be invested in the 401K because of the $17,500 limit.

In My opinion, I would certainly put in the 8% (or more) to get the 4% match. Then, I'd certainly max-fund the ROTH IRA.
Maybe that's about the extent of the investments, but if you could max out the ROTH, I'd adjust my Pre-Tax 401K contributions to make up the difference to max out $17,500 limit. I would also make 26 payments to take advantage of Dollar cost averaging.

In essence 17,500(MAX)-5,500 (RothIRA)= 12,000.
12,000 / 26 = $461.53 if paid biweekly to the 401K
(provided the 4% contribution by the company doesn't count against your 17.5K max, but I suspect it doesn't)

[Apex]

@jclimber,

Yes some do, but not the way the OP stated the plan description:

"They match 50% up to the first 8% I contribute"

To get the max of that you need to contribute at least 8% in every pay check of the year.

[Lemon Limey]

Old Limey?, Young Limey?, Middle Aged Limey?

Where is Baby Limey ?

[Ken M]

Hopefully you company does a true up contribution.

http://www.forbes.com/sites/ashleaebeling/2012/01/13/the-big-401k-match-mistake/

The person you talked to was wrong and didn't know what they were talking about or understand what you were asking.

Based on your 74k salary you should have been putting away 23.65% into your 401k to spread it out over the year if they do not offer a true up contribution not taking into account your extra earnings.

Save money in a ROth IRA that your only option. Then look into some low cost ETFs in a taxable account.

[Mike H]

My mistake... I think Ken's latest post makes more sense.

-M

[YoungLimey]

You are only putting away 30%? You better up your game.

[PenguinsManLimey]

I think we should all add Limey to the end of our user names. I'll start with this post.

[Lemon Limey]

@PenguinsManLimey

Amen.

[Rhyming Limey]

@ PenguinsManLimey

If anyone does not want to add "Limey" to the end of their usernames.....

I suggest we refer to them as (politely) as "Whiney Limey".

[YM]

OP here. Thanks for the help everyone. I didn't realize that by front loading contributions, I could miss out on reaping full benefits of employer match.

I've gone ahead and implemented Apex's recommendation to reduce my contribution to 8% for the rest of the year while also putting in $367 per biweekly pay period into a Roth IRA (I checked and saw that Roth IRA contributions deadline is April 15th of the next calendar year. I'll spread my contributions out to take advantage of DCA).

My 401K is with Fidelity. I have everything in a 2040 target retirement index fund. Returns haven't been the best in the world (6.1% YTD), but the expense ratio is only 0.08%.

Ed also made a really interesting point about the mega-backdoor: After-Tax 401K contributions-> Traditional Ira-> Roth IRA conversion. I'm strongly considering that as an additional option next year.

Thanks again!

[deserat]

I was thinking that your company might have a 401A, which is an after-tax vehicle which they can match as well. Where I worked before we had the 403B, company matched 2%, an 401A, company matched 5% and a traditional pension. 401A was for the employee after-tax dollar contributions - I would ask HR if that's where the money is deposited after the 401K/403B pre-tax contribuion limit is met..and we had Vanguard as our plan administration for all of these except the pension.

[Rich Guy]

I suggest doing 8% to get the employer match, and another 7% into a Roth IRA. Don't save any more than 15% to retirement.

Instead, pay off any and all debts. I bet a 25 year old has at least a car loan and student loans. Also, set aside several months of pay in a savings account. Then start saving for other goals like a down payment on a house or saving up to pay cash for your next vehicle.

Congrats on being a saver!!!

[bestmishu]

what nobody here seems to be considering is the quality of options available in the 401K. The advice I've always heard is that you are best to maximize the match, and then put the max out of the internal 401K given the likelihood you can get better (and lower fee) options from Vanguard or Fidelity

[Chris Lalor]

Vanguard & Fidelity = Lower Fees Max the Match!

[RA]

One key reason to max out a 401k and ignore an IRA is that if you are planning on retiring early, you can get at your money in a 401k without a penalty. At your savings pace, you should be able to retire early if you have access to your money.

I have changed jobs a couple times and I am constantly being pestered by mutual fund specialists to roll my old 401k's into an IRAs. When I bring up this one key point with regards to accessing money without a penalty, they quickly stop their sales pitch.