Question about maximizing 401k

[lifebeckonss]

Hi,

I am sorry if this has been addressed before, or if it sounds like "too basic" a question. I tried to search but could not find an answer.

In previous years I have not maxed out my 401k, but this year I am determined to. Based on my current contribution amount, I will not max it out so I need to change my contribution. I can only set a contribution percent as opposed to a contribution dollar amount.

Here's my calculation:
Max pre-tax contribution amount = $17,000
I get paid biweekly (26 paychecks per year). 5 paychecks have been paid so far and 21 remain.
Contribution made so far in 2012 = $1320.83 (in 5 paychecks)
Remaining 2012 contribution to max out = $15,679.17 (to be done in 21 paychecks)
Target contribution per paycheck = $746.63 (Remaining contribution / 21)

Since I can only specify a percent, this equates to 16.39% of my gross salary. However my plan allows whole numbers only. So I can do 16% or 17%.

Should I set it to 17%? This way my last paycheck of the year will need a contribution of about $200 to reach the $17K.

I don't want to go over the limit or remain under. I read somewhere that going over will not happen because my payroll department will stop my pre-tax contributions once I read $17K.

Pre-tax versus after-tax should not have a conflict because the 17% will be specified in my 401k as a pre-tax contribution. After-tax contribution is set to 0%.

Best Regards.

[cubaboymatt1316]

If you're dead-set on maxing it, and not falling even $1 short, go ahead and set it to 17%. I really don't see any major differences either way. Once you hit the annual limit, your plan administrator should cut you off immediately. That may or may not happen.

If they don't happen to catch it immediately, they'll catch it at the end of this year and refund you the money (plus or minus any market changes to those funds, I believe) and require you to pay taxes on it.

[livesoft]

You can do either 16% or 17%. You can check in December how you are doing and reset it. In our plan if someone uses the web site to change their percentage, it takes a few days to notify the HR person and sometimes that few days may end up being after the next paycheck. So if I want my percentage changed, I just walk into the HR office and have them change it for me in their payroll program.

As for whether your payroll folks will not overpay past $17,000 you really have to ask them.

If there is a company match, you need to determine if hitting $17,000 before your last paycheck will effect any match formula.

[DAK]

I try to max my 401 by February...I set a high % on the website to do this...it doesnt matter if I go over because payroll caps the total contribution at $17,000 (for 2012)

Call your payroll dept. and if they cap it you cant go over....if they dont then you have to be careful

[lifebeckonss]

Thanks livesoft, cubaboymatt and DAK. I will check with HR about the over paying rules as well as impact on company match.

By the way, when I was searching on the web about this, I found the following advice from a financial planner. He almost seems to be discouraging people from maxing out their 401k's. I can see the validity of his point # 1 about having an EF first. I just wonder what the Bogleheads think about this view.

As a CFP, I advise all my clients to never put more than 7% of total income in a 401(k) or other qualified plan. Here are some of the reasons for my recommendations.

1. Don’t try to put the maximum into a 401(k). A good rule is not to start your 401(k) until you are setting aside 15% of annual income in safe, fixed, saving vehicles like money market accounts, savings accounts, CD’s etc., until you have at least 50% of one years income. If you research some of the questions here on Askville, one of the things you will see asked most often is, "how do I get money out of my 401(k)?" This comes up because too many people started putting the maximum in the retirement account before have liquidity someplace else. Then when they need money in an emergency, (laid off, medical, disability,) they reach for the only large source of money they have, the 401(k). (Then they face tax and penalty.)
2. Once you have 50% of one years income saved, start the 401(k) using 7% of the 15% or up to the company match, whichever is greater. The other 8% should be moved into an investment portfolio outside the 401(k) that fits your investment risk profile.
3. 401(k) plans are tax deferred plans, not tax advantaged plans. Too many financial planners interchange the terminology. A 401(k) allows you to deferrer taxes. This means there is part of your 401(k) that you will never have access to. Most people don’t understand the tax savings is locked in the plan. You never have access to it, that is why it is deferred. For example, if you were to put 7% of $100,000 ($7,000) each year for the next 35 years at 5%, you would accumulate $663,854. $100,000 of income would put you in the 28% tax bracket if single, so you would save $185,879 in taxes. (This assumes you always earn $100,000 a year) Assuming you are in the same tax bracket at retirement (28%) you will owe $185,879 in taxes, exactly the same that was deferred. You never got to spend the $185,879. You are left with $477,975 to spend.
4. Don’t think you will be in a lower tax bracket at retirement. Most people are in the same or higher. And with the way the government is spending money, there is a good chance you tax bracket at retirement could be double what it is now. That means you will give back twice what you got credit for. Remember, you give up almost all money control with a qualified plan. In 1973 when the first IRA law was passed, top marginal tax brackets were 70%.
5. Equity investments inside a 401(k) are taxed at ordinary income rates instead of capital gain rates. So any mutual funds or stock you sell inside the 401(k) at retirement will be taxed at ordinary income tax rates, (as high as 35%) instead of the capital gain rate of 15% outside the plan.
6. You can not tax deduct investment losses inside a 401(k). You can if the investment losses are outside the plan.
7. The government has a Required Minimum Distribution rule at age 70 1/2 that says you must start taking money from your 401(k) whether you want to or not. This distribution is based on a government table. http://www.bankrate.com/finance/money-g ... table.aspx. The figures are the same for IRA and 401(k). This means you have no control over how much income you take after age 70 1/2. You must take the minimum. This gets added to interest, dividends, Social Security, pensions and any other income source you have to determine your taxable income for that year. Here is a calculator to let you play with a 401(k) balance to see what the minimum is. http://www.cpasitesolutions.com/content ... strib.html. Notice how clever the government is. If you just take the minimum, the amount you need to take each year increases, pushing you into a higher tax bracket. (Unless you have a major loss inside the plan.)
8. Watch out for plan fees. Some of these 401(k) plans can have very high fees, (150 to 200 basis points, 1 1/2% to 2%.) These fees can really eat into your account balance over the years.
9. Make sure you have a well planned exit strategy. Most people have good entrance strategies, but never look at the tax consequences, minimum distribution calculations, or what can happen if tax laws change.

[cubaboymatt1316]

This site's wiki has some great information concerning your EF. How much is in it and where the money is kept will depend on your own lifestyle and preference. Most of the advice given on this site, from what I've seen so far, is assuming you have no consumer debt and already have a sufficient EF unless otherwise noted.

Emergency Fund

[interplanetjanet]

By the way, when I was searching on the web about this, I found the following advice from a financial planner. He almost seems to be discouraging people from maxing out their 401k's. I can see the validity of his point # 1 about having an EF first. I just wonder what the Bogleheads think about this view.

The advice you copied and pasted shows a misunderstanding of the benefits of tax-advantaged plans, and a lack of basic math skills. At its best, it's a display of ignorance. I don't really even know where to start but I'm sure some others here will try.

-janet

[dickenjb]

Be careful as some employers will just not take anything out of the last pay in December if that would put you over. And then you will be way short and possibly lose matching contribution for that pay cycle.

Set it at 17% now. Call payroll and find out what their policy is. If they will take out exactly 17,000, great. Get it in writing. If not, move it down to 16% halfway through the year or whenever you calculate the right time to switch to 16% is (to have $16,990 taken out).

At my former employer, I could never hit the max. I was not allowed to change my percentage during the year, only could make one election in December of the previous year. Some years I was $300 or $400 below the max. We could only do whole percentages as well. They would send us highly compensated employees an Excel sheet into which we would plug our base pay and it would tell you what % to specify to get as close to the max as possible. The $5000 in catch up contributions were specified in dollar terms so I could always hit that exactly.

[lifebeckonss]

This site's wiki has some great information concerning your EF.[/url]

Thanks Matt. I read the Wiki regularly, it really has a wealth of information in there.

The advice you copied and pasted shows a misunderstanding of the benefits of tax-advantaged plans, and a lack of basic math skills. At its best, it's a display of ignorance. I don't really even know where to start but I'm sure some others here will try.-janet

Thanks Janet. Like you, I also do not agree with the advice I copied and that is why I am maxing my 401k this year. In a way I was shocked to see that advice as coming from a CFP. Just goes on to show the quality of financial planners out there who are directly dissuading people from maxing out their 401ks. I posted it only because it was relevant to my question and I stumbled upon it in my search, and I wanted to get a take of Bogleheads on that.

Set it at 17% now. Call payroll and find out what their policy is. If they will take out exactly 17,000, great. Get it in writing. If not, move it down to 16% halfway through the year or whenever you calculate the right time to switch to 16% is (to have $16,990 taken out).

Thanks Dickenjb. I will check with payroll on Monday. I wish they had a fixed dollar per paycheck option so I didn't have to monkey around with percentages. But not a biggie

[Default User BR]

I don't want to go over the limit or remain under. I read somewhere that going over will not happen because my payroll department will stop my pre-tax contributions once I read $17K.

Read where? In your plan documents? This is strictly up to the individual plan. Mine switches to after-tax when the deferred max is reached (which is a good thing).


Brian