You’re a disciplined saver and investor. You have diligently maxed out your 401(k) plan each year. Well done! This is a big step towards maximizing your financial independence.
In addition to your savings, your employer may provide a generous match on 401(k) contributions. However, it's important to note that maxing out your 401(k) could actually cost you thousands of dollars in free money from your employer, depending on the specifics of your plan.
You heard that right! It's possible that maxing out your 401(k) before the end of the year could have negative consequences if your employer's 401(k) plan doesn't include a "true up" feature.
Once you've reached the maximum 401(k) contribution amount for the year, you will no longer be making 401(k) contributions from your paycheck. This means your employer doesn't have any contributions to match, which can add up to a significant amount of lost money without the true-up.
Almost half of employers don't offer true-up provisions, making it important to plan ahead and maximize your employer match to avoid missing out on free money.
The "true-up" feature of a 401(k) plan allows employers to make up for any missed matching contributions during the pay periods after you have already reached the maximum contribution limit.
In simpler terms, if your contributions stop because you hit the maximum employee contribution limit, your employer will calculate the amount of matching contribution owed to ensure you receive the full match for that year.
Let me share a simple example to help you understand the impact of not having a true-up feature.
Meet Mike, who has an annual salary of $300,000, which amounts to $25,000 a month. He has decided to contribute 12% of his salary towards his 401(k) plan, which means his monthly salary deferrals are $3,000 (12% of $25,000).
Mike's employer matches 100% of his contributions up to 3% of his salary, which is equal to $750 per month (3% of $25,000).
However, Mike has never paid much attention to his 401(k) plan details, and his employer doesn't have a true-up feature. Since Mike's savings rate to his 401(k) plan is high, he reaches his employee deferral limit by the end of August. This means his contributions to the 401(k) plan stop, and his employer has no more contributions to match for that year.
Without the true-up feature, Mike is missing out on $3,000 of free employer money (four months of matching contributions). This also means that his effective employer match comes down to 2% instead of the 3% offered by his employer.
This is illustrated in the chart below. Notice that the employer match stops when Mike’s contributions stop in August when he maxes out his 401(k) plan ($23,000 in 2024).
This can have an even larger impact on an employee who front-loads a 401(k) plan earlier in the year, such as from a bonus. For instance, if Mike receives a bonus in March and decides to front-load his 401(k) contributions to the max employee deferral limit of $23,000, he would lose out on nine months of matching contributions, amounting to $6,750!
If an employer doesn't offer a true-up feature, there are a few ways to maximize your employer match.
One of the easiest ways to ensure that you capture the full employer match in your 401(k) plan is to recalculate your contributions and spread them out evenly across the year. Ideally, you should try to hit the 401(k) employee deferral limit on the last paycheck of the year.
Remember in our example that Mike contributed 12% of his salary to his 401(k) plan, which caused him to reach the 401(k) employee deferral limit in August.
To get more money from his employer, Mike can recalculate his savings percentage from his paycheck so that he spreads out his contributions evenly throughout the year.
In this case, if Mike wants to continue to max out his 401(k) in 2024 at $23,000, and he expects his earnings to remain the same, he can calculate his new contribution amount as follows:
$23,000 divided by $300,000 equals approximately 7.7% or $1,916 per monthly pay period.
Illustrated in the chart below, we can now see that Mike has spread his contributions across 12 months, which allows his employer to continue matching through December. This results in $9,000 of matching contributions from his employer instead of only $6,000 as he was getting before.
A simple change to his contribution percentage has resulted in an additional $3,000 per year! For Mike, that could be an additional $148,000+ in total value over 20 years (assuming $3,000/yr for 20 years, earning 8%).
Another option is to check your contribution choices in your plan details. Some plans without a true-up feature may have options to defer excess or make after-tax contributions to your 401(k). Even after reaching the employee maximum limit, you may be able to continue contributing to your plan and receive matching contributions from your employer. Just make sure that these contributions are eligible for your employer match.
If you elect excess or after-tax contributions, you’ll want to manage these contributions, which can potentially be converted via Roth in-plan conversions (if plan allows). This will allow the after-tax money and potential growth to benefit from tax-free compounding inside the Roth.
If you have contributed the maximum amount allowed to your 401(k) plan for the year, you may notice that your pay stub no longer shows a matching contribution. To confirm this, check your recent pay stub for the line item that shows your employer match. If it displays $0.00, it could be because you have reached the maximum limit. However, this doesn't necessarily mean that you won't receive the match.
Even if you haven't hit the contribution limit yet but plan to do so during the year, here's how you can check if your plan has a true-up feature.
Grab your 401(k) Summary Plan Description (SPD) to get information about your company's matching policy. You may also check the 401(k) supplement documents for this information.
Rather than digging through your documents (which sometimes can be unclear anyway), you can contact your HR department and ask if there is a true-up feature. Inform them that you want to know if they will apply matching contributions for pay periods after you hit the maximum employee 401(k) limit. Have them point you towards this in the 401(k) summary documents.
If you max out your 401(k) plan and receive an employer match, you want to be aware of the true-up feature. You don't want to potentially miss out on thousands of dollars just because you are maxing out your 401(k)!
As a reminder, the maximum employee 401(k) deferral in 2024 is $23,000, with an additional $7,500 for those aged 50 and above. The total limit for 401(k) plans in 2024 is $69,000 or $76,500 for those over age 50.
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