Quora Question on 401k Contributions Brings Up Great Points
This (post title – Can I Contribute Money to my 401(k) That Wasn’t Made at My Job?) was a great question and one that pops up frequently. I had the opportunity to answer this on Quora, which you will find the link to below.
It also opened up a second point in my mind, which I shared on Quora regarding the 401(k) “match trap” that happens when employees front-load contributions.
The key takeaways are that you can not contribute to your 401k money that was earned from a different source. And that front loading contributions to your 401k might cause you to lose the full year’s match (and a lot of money) vs contributing evenly throughout the year.
Can’t Bring Outside Money to Your 401k
You can only contribute elective deferrals to your 401k. that means money deferred before it gets into your hands. Which, unfortunately, means money you earned last month and is now in your bank can not be recycled back into the 401k. It has to come from current or future pay cycles.
One challenge here is that if you go all year without contributing, the only way to catch up is if your salary is high enough to allow you to get the maximum $19,000 contribution ($25k if over age 50) in a short period of time. For example, if December 1 rolls around and you haven’t contributed anything, and you want to max it out, you better have a salary 19k/mo (plus bonus coming) or greater, or you aren’t maxing it out!
Who might want to catch up all in one month? Someone getting an inheritance. They could defer 100% of their salary and live off the inheritance cash. As I mentioned on Quora, this is an excellent tax saving strategy.
Moreover, maybe your spouse got a bonus and has maxed out their 401k. You could use the bonus money to live on and offset some of the tax by maxing your 401k.
Don’t Lose that Match
One of the risks of front loading 401k contributions is potentially losing out on the full company match.
The example I shared in Quora had to do with someone who used their year end bonus received in January to front load their 401(k) contribution for the year. Hence, the problem could be if the company match is factored on compensation year to date. Here’s a hypothetical example:
Company match = 100% up to 3% of salary
Employee gets a $20,000 bonus in January, and makes a $19,000 maximum 401k contribution. The match is 100% up to 3% of income which = 3% x $20k bonus + $10k salary = $900. The match for the year totals $900.
However, Let’s say employee instead contributes $1,583.33/mo for 12 months. Each month the employee would contribute that sum and get a match of 3% of $10,000 monthly salary, or $300. But they would get this for 12 months. The match for the year totals $3,600.
401(k) best practices are supposed to guide employers to educate employees about this and many plans offer true ups to make up these shortfalls. Unfortunately, many still don’t (this Forbes article highlights some 401k issues).
Who’s Looking Out for You?
Your best bet might be to have a planning team that is aware of these small nuances in all areas of planning that can add up to six or seven figures net to your lifetime bottom line. Furthermore, you need a team of diversely skills pros that can communicate so that each area of personal finance: investment, insurance, tax, legal, debt, credit, cash flow, benefits, work all “talk” to each other.
And you need an organized team leader to pull all of this together for you. Curious where you can find one? Learn more HERE.
Why waste your valuable time trying to figure this all out?
“True Wealth is Discretionary Time” ~ Jim Rohn
Reference my original Quora answer here (thanks for reading!):
Photo credit: Flickr User Mark Turnauckas