Tuesday, October 24, 2006

Countdown to Maxing out the 401k

A few months ago, I decided to cut back on my 401k contributions a little bit. I wanted to make sure I'd have plenty of liquid cash on hand for buying and furnishing my condo-- my budget allows me to save money almost every month already, but I wanted to be doubly, triply sure! As it turns out, I think I'll be fine and might not have needed to change the 401k deductions, so last week I decided to increase my contributions again to see if I can make it to the $15,000 maximum by the end of the year. I also want to contribute the maximum amount to my Roth IRA for the year.
For the last few months, I'd been contributing 10% of my pay to the 401k, and now I've bumped it up to 20%. As of my last paycheck, I'd contributed $9110. The new contribution that should go into effect for the last 5 paychecks of the year is $737.50, so I'll fall short by a couple thousand dollars. I'll probably have to do what I did last year-- change my deduction to some absurdly high percentage so I barely get any pay that week! I think the maximum is 60%, so I'll have to send that change through soon in order to catch enough paychecks before the end of the year.
I know some people don't recommend maxing out a 401k-- they suggest contributing only as much as you need to to maximize your employer's matching contributions, then maxing out a Roth IRA, and then investing any other savings you have left in other investments. With a 401k, you avoid paying taxes on the money now, but must pay taxes on it later. With a Roth, it's just the opposite-- you pay taxes on the money now, but you won't have to when you withdraw. For many people, especially someone my age or younger, chances are good that your tax rate will be higher later on, as you advance in your career and make more money-- so it makes sense to maximize the Roth now, but I could end up paying more in taxes on the 401k money. I've decided to take that gamble-- to me, it's more important to have the enforced discipline of regular payroll deductions and have the money in an account earmarked only for retirement, with a strong disincentive to withdraw any of it early.
As I've said in my Rule #6, I think it is important to get into the habit of funding these retirement accounts early. I always participated whenever I could, starting with my first job. I actually tracked the history of my contributions and in the first few years, they were fairly low-- I think at the time, I thought 15% of your pay was the maximum you were allowed. Maybe that was true at the time, I don't know. There were also a couple of job changes that prevented me from contributing for periods of time-- one employer didn't allow you to participate until you'd been with the company for 6 months or a year, I think. My lifetime total of 401k contributions through my last paycheck is $81,559. The balance of my 401k account right now is $147,463. That 80% gain makes me pretty happy. Of course part of me wonders if I could have done even better with different fund choices, but I'm about due to reexamine those soon, so I'll save that for a different post!


Tiredbuthappy said...

Wow, go you, Madame X.

I dream of maxing out my Roth, much less my 401k.

Maybe someday....

Lazy Man and Money said...

I actually put my contributions at 75% for 2 months before I left my last job. I was relocating for my fiancee's promotion, so I didn't know what job I was going to have or if it would have a 401k. Turns out it didn't have a 401k plan, so I'm really happy that I plowed a ton of money into it.

The downside is that I borrowed a little from my home equity line to do it (only about 1/10th of what I ended up putting in). I need to pay that off now, but I think it's really a small amount of interest to pay to get money to grow tax free.

Kate said...

I have decided (I think) not to contribute to my 401K while I still have significant debt. I figure it's better to pay down the debt first, because I'm paying interest on it, and eventually I will have to pay taxes on the 401K, which lowers the value of the employer contribution. What do you think?

Wanda said...

Hey Madame X,

My company says they will "match 75% of the first 4% of employee contributions"... does that mean that they will match 75% of 4% of $15,000 (if I max out the 401(k)).

I think that match turns out to be only $400.. that seems a bit low (not that I am complaining about any free money). Am I missing something here?

mOOm said...

Kate - it usually makes sense to contribute money up to the employer's maximum match even if you end up withdrawing the money and paying the 10% penalty when you quit unless the employer pays very little in matching funds per dollar the employee contributes. Of course if you are likely to leave before the employer contribution vests then the equation is different.

Wanda - I think they mean that if you contribute 4% of your salary they will add 3% of your salary to the account.

Akesha said...

Kudos Madame X

I wish I had your discipline. Right now I only contribute enough to my 403(b) (same as the 401 but I work for a non-profit) to take advantage of my employers match.

I too am working on paying off debt. Which has all been consolidated and I think I should be finished with that next year.

Mase said...

FYI -- your Rule #6 link in the left box is not working at the moment (the other rules appear to be working fine).

KKarma said...

Hi Madame X,

I am an occasional reader of your blog and love it. This is my first post here. I thank you and other women bloggers (especially Boston gal) for keeping your financial books open to us.

Any way,

For me, I don’t see any financial emergency coming requiring me to tap into my current paychecks for this year.

So, I have decided to maxout my 401k as well for this year. So far I have contributed $9997 (as of 10/13/06). I have 5 more pay checks to go. Last one will be on 12/22/06.

I have decided to contribute at the rate of 50% for the next three paychecks. After that, I’ll see how much I need to decrease in order to not go over $15000 limit. I am not sure how it works if I over contribute. Or would it jus not take money out of my pay check after the max is hit? In anycase, I don’t want to ‘not contribute’ as I would be missing my employer’s match of 80% of 5% I put in. Does it make sense?

My problem is I get fixed salary + all the holidays I work. I work for a company that runs 24/7 and if my working day happens to fall on a holiday, I get paid 2.5 times my normal pay. This sort of throws me off my calculation.

Though, looking at my last year’s contribution, I was very aggressive and put in $5100 in November and December (4 pay checks) combined. If it goes anything like last year, in theory, I should end up putting more money. Hence, only going put at 50% rate for the next 3 checks.

About the Roth, I sort of started at it little late. But, that’s ok. I started contributing to Roth as of this year. At the beginning of this year I opened and funded Roth IRA with $8000 (for 2005 and 2006). So, I am done with that.


Madame X said...

You don't have to worry about over-contributing-- your company will just stop deducting for the 401k once you've hit the maximum.

Thanks! Rule #6 is back now.

KKarma said...

madame X,

Thanks for the info.


Ron said...

You are right according to this article you may have only been allowed to contribute 15%:


"Before 2001, the employee's 401(k) contribution plus the employer match could not be more than 25% of a worker's income, so some employers capped their employee contributions at 15% to make sure they fell within those limits, says Rick Meigs, president of the 401khelpcenter.com."