Now or Later?
With a new year comes new resolutions and for savers, new retirement plan contributions.
For 2024, the employee contribution limits are as follows:
IRA and Roth IRAs : $7,000 for those <50 years old, $8,000 for those 50 and older.
SIMPLE IRA: $16,000 for those <50 years old, $19,500 for those 50 and older.
401k, 403b, 457 plans: $23,000 for those <50 years old, $30,500 for those 50 and older.
If increasing your retirement plan contributions are a goal for this year and you are feeling extra motivated to max out your contributions, you may be asking yourself, should I try to max out my contributions earlier on in the year and check that goal off my list?
The answer is…. It depends. Helpful, I know…
First off, it is critical to think about realistic cash flow before dumping all of your money into your 401k plan right away in the year. Will your cash flow be able to accommodate this lowered income in the months you are maxing out your contributions? Also,it’s important to consider how frequent your employer will let you update your contribution amounts so that if you have to dial back due to an unforeseen need for additional income, you are able to do so in a timely manner.
The majority of employers match a certain percentage of an employee’s contributions up to a percentage of their salary. For example, 100% of contributions up to 4% of their salary or 50% of contributions up to 6% of their salary.
If your employer provides a match, it is important to confirm with your plan administrator that they provide what is called a “true-up provision”. A true-up provision requires an employer to make an additional end-of-year contribution to an employee’s account if the employee hasn’t received the full match they were entitled to under the terms of the plan. In laymen’s terms, a true-up is a way to make sure that any employee who participates in the plan receives an employer match that reflects their total contribution for the year, rather than a lesser amount.
If your employer plan does not have a true up provision, then you could potentially be missing out on employer match by front-loading your contributions in the beginning of the year. Here is an example of how it would work:
Let’s say you make $100,000 gross salary, you want to max out your 401k ($23,000 for those under 50 in 2024), and your employer matches 100% of your contributions up to 3% of your salary.
- Scenario #1: To max out your contributions in equal amounts throughout the year, you would need to contribute 23% (roughly $1,916.66) every month to complete the total of $23,000. Each pay period, your employer would contribute $1 for every dollar up to 4% of your salary (roughly $250), for an annual total of $3,000.
- Scenario #2: But what if you were to contribute more than 23% per month? Let’s assume that your financial situation allows you to contribute a 50% deferral every month. If you were to do that, then you would contribute $4166.66 every month and max out your contributions in a little over 5.5 months. Since your employer only contributes up to 3% of your gross pay or about $250 per month, you’ll only receive a total of $1,375 ($250 per month x 5.5 months to maximize early) in matching contributions for the year. If there was no true-up provision in the plan, you would be missing out of the extra $1,625 of employer matching contributions.
However, if your employer sponsored plan does provide a true-up provision and you have the financial means to max out your 401k early on in the year, should you? From a pure return perspective, the average stock market return is about 10% annually over time, so since markets tend to go up there is a potential slight advantage to getting your money invested sooner rather than later.
Nick Maggiulli, the Chief Operating Officer for Ritholtz Wealth Management LLC, and his team performed research on the differences between “Max Early” and an “Average-In” strategy on 401k contributions. Their research found that the biggest difference is due to maxing out early for multiple years in a row, ideally for at least 10 years.
In the below example, for each year Max Early would contribute $20,000 in January while the Average-In contributed $1,667 each month for 12 months. They ran the simulation and compared the performance between the two strategies for each 10 year period since 1978 up until 2022.
The $0 line can be thought of as the dividing line between which strategy performs better. And clearly there is more mass on the right side.
So is there a sizeable difference? Further into their research they found that the Max Early strategy would result in having about 5% more than if you Averaged-In. (You can read the full article here – https://ofdollarsanddata.com/max-out-401k-early/) Keeping in mind this research is based on maxing out the 401k roughly the first 2 months of the year which would assume that you are making at least $276,000 in 2024.
While maxing out your 401k early in the year may not be feasible, maxing out Roths or IRAs (if you are eligible to contribute) earlier in the year may be a more manageable bite to chew.
The goal of maxing out your retirement plan is an excellent one if cash flows allows and if possible is highly encouraged. But even just meeting the match and eventually aiming for 15% of total contributions (which can include employer contributions) is an excellent start to retirement savings.
Speaking with your financial advisor is a great way to start planning for these increased contributions!