Not one to make New Year’s resolutions?
Fine, but you may be missing out if you don’t resolve to maximize your 401k plan this year.
If you’re already contributing the full amount allowed and leveraging an employer match, you’re off to a great start. But there’s more you can do to supercharge your 401k.
Emulate the Optimal Portfolio
Unlike a brokerage account that can invest in virtually any publicly traded stock or mutual fund, 401k plans are limited to investment funds provided in a plan’s lineup.
Vista recommends a mix of investment choices that closely mirrors the Optimal Portfolio. This emphasizes low-cost index funds and keeps a lid on fees—ultimately maximizing 401k contributions.
Leverage the Employer Match
Not taking full advantage of a plan’s employer match is leaving real money on the table.
Spreading employee contributions evenly throughout the year versus front-loading contributions can have a dramatic effect on the amount an employer contributes to the plan—so it’s important to understand how different plans calculate the employer match.
True Up Contributions
Some plans only provide a match during pay periods in which the employee makes a contribution.
Certain employers will true up contributions, which means participants receive a matching contribution based on annual deferrals into the plan, regardless of timing.
A Deloitte study found that nearly nine in ten companies match per pay period—and just 45% conduct a true-up.
Timing Matters
What does this mean for you? Take two workers, Alison and Jeff. They both earn $100k per year and defer 19% of their annual salary to their 401k.
Alison evenly disperses her contributions throughout the calendar year. Her employer match is $250 per month, or $3,000 a year. This makes her total annual employee and employer 401k contribution $22,000.
Jeff, on the other hand, frontloads his 401k contributions over the first 3 months of the year. This is generally a reasonable strategy—it allows Jeff to productively invest his contributions sooner.
Jeff’s employer match is also $250 per month. Without a true up plan provision, however, he loses out on his employer match. Jeff only gets $750 a year—$250 for each of the three months he makes a contribution.
By not contributing throughout the year, Jeff leaves $2,250 on the table. His total annual employee and employer 401k contribution ends up being only $19,750.
Optimize Pre-Tax vs. Roth Contributions
After leveraging the employer match, an employee may be able to choose between making traditional pre-tax contributions or after-tax Roth contributions.
Depending on an individual’s tax bracket and time horizon, the Roth election could be favorable.
In 2019, an employee can make up to $19,000 in pre-tax or Roth 401k contributions. Employees over 50 can make an additional $6,000 catch-up contribution.
It’s worth noting that while some plans allow the employee to direct their contributions to pre-tax or Roth, employer contributions will always be allocated toward the pre-tax portion of a 401k plan.
Make After-Tax Contributions
Some plans also allow employees to make additional after-tax contributions to their 401k once the $19,000 maximum is met.
Suppose someone socks away $19,000 in employee contributions, $9,500 in employer contributions, and an additional $27,500 in after-tax contributions in their 401k.
While earnings on these funds do not grow tax free (unless the plan allows a backdoor Roth conversion), a few years of maximum after-tax contributions will add up to a sizeable amount that could eventually be moved over to a tax-free Roth IRA.
Look for the Backdoor
To isolate after-tax contributions and immediately convert these funds to Roth 401k investments, some plans include a provision known as a mega backdoor Roth contribution.
This feature, when available, is the ultimate boost to a 401k because it allows after-tax contributions to grow tax free.
Vista Can Help
To maximize your 401k, call us to discuss your goals and plan provisions. We are happy to help.