If you’re not careful, you might not get the maximum from your company’s 401K match. No, I’m not talking about contributing too little to get the full match, I’m actually talking about contributing too much to get the full match.
Here’s the problem:
There are contribution limits to your 401K set at $15,500 for 2008 ($20,500 if your 50 or older).
Let’s assume that your company match is 50 cents on the dollar up to 6%, which is a hypothetical but common matching plan. So if you contribute 12% or more, you should get the full company match of 6% (12% x 50/100 = 6%). But there is still a potential problem. If you contribute too high a percentage of your salary, you might hit the contribution limit before the end of the year. For many 401K plans, that means that you’ll miss out on the company match for all paychecks past that point.
Here’s a quick example of how that could happen. To keep things simple, let’s assume that you make $120,000 a year, contribute 20% to your 401K, and get paid once a month. Each paycheck would be for $10,000, and you would contribute $2000 to your 401K. Since you contribute at least 12%, your employer would match 6%, or $600 a paycheck. In this scenario, you’d hit the contribution limit after 8 months, since 8 x $2000 >= $15,500. At that point, your employer would have contributed at most $4,800. In the remaining 4 months of the year, you would contribute 0%, since you’ve already hit the limit. Subsequently, your employer would not add any matching because for those periods, you made no contribution. So instead of the $7,200 match you expect from your employer ($120,000 x 6%) you’d get at most $4,800.
This hypothetical example was an exaggerated version of what could happen to you to show how it happens. The lesson here is that if you hit your contribution limit before your last pay period, you may miss out on company matching. I say “may” because some employers have noticed this problem and changed their plans to give employees the maximum match if employees hit the contribution limit. If you’re not one of the few lucky ones with this updated provision, then pay careful attention not to hit the contribution limit until your final paycheck of the year.
This post has been updated. In my original version of this post, I incorrectly stated that this problem had to do with company match contributions counting towards your maximum contribution limit. Thanks to Sarah for pointing out that error.
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