401k Company Match: How To Maximize Your Free Money

Mar 28, 2023 | Feature, Newsletter, Retirement Plan, Retirement Planning, Retirement savings

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Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Monday April 3, 2023. 

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

401k Company Match: How To Maximize Your Free Money

In this newsletter, we will discuss in some details on how to maximize your company or employer 401k match. We also looked some nuances in terms of getting the match and then proceed to discuss whether it’s always better to maximize your 401k contribution and match.

401k company match: a free money that you shouldn’t ignore

Employer matches are a valuable benefit that many employers offer to encourage employees to save for retirement and also as an incentive or perk to attract and retain talents. When you contribute to your 401k account, your employer may also contribute a certain percentage of your salary to your account as a match. This means that by contributing to your 401k account, you are effectively getting free money from your employer.

By maximizing your employer match, you are taking advantage of this free money and increasing the amount of money that is being saved for your retirement. Over time, the extra money from your employer match can really add up and make a significant difference in the amount of money you have available for retirement.

However, if you cannot afford to maximize your employer match, it is still a good idea to contribute to your 401k account at a level that is comfortable for you. Even if you cannot maximize your employer match, any amount that you contribute will help you save for retirement and take advantage of the tax benefits of a 401k account.

Factors and limits

Some details on 401k contribution and match:

There are two factors for a company match. The first is how much percentage the match is. For example, a company can decide to match 100% of your contribution or just 50%.

The other factor is the upper limit of the match, usually is a percentage of your salary or compensation (in general, it includes irregular bonus also). This number varies greatly. We find 2% to 4% are fairly normal these days. 

Annual limit: a 401k contribution is also subject to annual limit. For 2023, 401(k) contribution limits for individuals are $22,500, or $30,000 if you’re 50 or older.

Combined contribution and company match limit: Notice that the company match amount is not included in the above individual annual contribution limit. However, the combined amount (your contribution and the company match) is subject to another limit: for the tax year 2023, that limit stands at $66,000 ($73,500 when you include catch-up contributions for workers 50 or older). This means that together, you and your employer can contribute up to $66,000 for your 401(k).

The above factors and limits can be confusing for many people. In the following, we will discuss some nuances or mistakes people often make.

Nuances

Some nuances you need to watch out. First, notice that the match limit (say, 4% as an example) is only up to each pay period, not just for the annual pay. We have a subscriber who wanted to take advantage of investing early by making a big deduction (so that it can quickly reach annual maximum threshold earlier to maximize time to invest) at each period. In this example, the person designated 40% of his paycheck to 401k contribution, thinking about that will get his money invested in 401k as soon as possible and also get the 4% match. Unfortunately, it turns out the 4% match rule is not only limited to the annual salary cap, but also to each period. Since this person’s monthly gross pay is 20k (again, for illustration purpose), and he designated 40% deduction, a bi-weekly contribution would be $4000 but since the 4% is limited to the 10k gross pay too, he only gets $400 match for each period when he contributes.

So it turns out that his contribution will max out in the 6th pay period because it reaches the annual contribution limit. So this person only gets $400×6=$2,400. On the other hand, if he were to spread out his contribution evenly for each period (i.e. 22500/24=$937.5 in each period), he would have gotten $400 (as company matches 100% up to 4% of each period) for each period that amounts to $400×24=$9,600, $7,200 more than $2,400 he had gotten! Note in this case, the combined amount of the contribution and the match is $22500+$9600=$32,100, which is still within the annual limit.

In general, as a rule of thumb, for those whose pay is high, it’s better to spread out contribution evenly to each pay period to maximize the match.

Is it always better to maximize your 401k contribution and match?

The answer regarding whether to be always better to maximize match seems to be a no brainer: sure why not? This is ‘free’ money for you. In fact, depending on your pay, you basically are getting a raise of a similar percentage (in the above example, 4% raise!).

However, to answer whether it is always better to maximize your 401k contribution, things become somewhat complicated.

Many people are wondering whether to maximize 401k contribution if currently your tax rate is low and you expect you will reach some very high tax bracket when you are retired or start to withdraw money. In the following, we look at a simple scenario:

contribution amt current tax rate years to withdraw annual return tax rate at withdrawal time capital gain tax amt after withdraw
max out 401k contribution 20,000 20% 30 10% 50% 35% 174494
some contribution 10,000 20% 30 10% 50% 35% 87247
taxable 10,000 20% 30 10% 50% 35% 90736
subtotal 177983

In this above example, we look at one way that contributes 20,000 to 401k and then withdraw after 30 years at a max tax rate of 50% vs. the other way that only contributes half (10,000) and leaves the other half of 10,000 to be invested in a taxable account. We further assume that the taxable investment is through a buy and hold for 30 years with the same 10% annual return and 35% long term capital gain tax. Both income tax (50%) and long term capital gain tax (35%) reflect state tax in a high tax rate state like California.

From the above example, one can see that the final outcome is about the same. There are some pros and cons to have taxable part. The pros include that the taxable part is more liquid and can be used in case there is a need of the money in the future. However, this assumes that you really buy and hold and if you need to be tactical, the outcome might be very different. Furthermore, one needs to be very disciplinary to keep the taxable amount invested during the 30 years.

On the other hand, if the current tax rate is higher like 20%, the second scenario actually yields less.

It’s also obvious that if you can get the company match (if any), the above figures can change quickly. The match certainly can make a difference:

contribution amt current tax rate years to withdraw annual return tax rate at withdrawal time capital gain tax amt after withdraw
max out 401k contribution with 9,600 match 29,600 20% 30 10% 50% 35% 258251
some contribution with half 4,800 match 14,800 20% 30 10% 50% 35% 129125
taxable 10,000 20% 30 10% 50% 35% 90736
subtotal 219862

So now we are seeing the difference of the free money makes.

To summarize, if you can afford it, it’s generally good to maximize out your 401k contribution and the match, even after tax consideration at the future time when you retire or start withdrawing money. However, there are some specific considerations such as future need of some portion of the money that have to be taken into considerations.

Market overview

More and more indicators are pointing to a declining economy: the unemployment rate has risen to 3.7% from 3.4% and both retail sales and industrial production indexes in last month are now less than those one year ago. In our opinion, the likelihood of a recession in the coming months has increased substantially.

On the other hand, as what we wrote in our previous newsletter on the recent banking crisis (Silicon Valley Bank and other regional banks and then Credit Suisse), we recognize that banks are now forced to protect their deposits by raising interest rates for deposits.  To compensate the loss, they will also tighten their lending standard and, with the last week’s another 0.25% interest hike by the Federal Reserve, they will increase their loan interest rates (that again makes borrowing more costly). In fact, many banks have announced to increase their prime lending rate to 8% in the past week. So the banking crisis will no doubt further help the Federal Reserve to tighten financial condition that might likely tip the economy into a recession (or maybe we are already in one?).

Stocks, on the other hand, are still hanging tough as of now. But we believe things will become more clear in the next quarter. At any rate, we are cautious.

As always, we call for staying the course which is guided by some well defined and sound strategies:

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or preferably much longer given the current high valuation. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later and preferably many more years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Stock valuation has dropped and now valuation is becoming less hostile. However, it is still not cheap by historical standard. For the moment, we believe it’s prudent to be extra cautious. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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