Front Loading 401(k) Contributions

401(k) plans are a common retirement savings vehicle for people employed in the private sector in the United States. There are tax incentives for contributing to a 401(k) offered by the US government. The IRS has a great synopsis and more resources than you would ever want to dig through regarding the 401(k). A key feature of the 401(k) plan is its contribution limits. For 2018, the tax incentivized contribution limit is $18,500. From the IRS:

A 401(k) is a feature of a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts.

Many companies allow a percentage of your paycheck to be input into the 401(k) account and they will in turn contribute equally to your account up to a percentage of your total salary. This is often referred to as a company match percent. For example: if you make $50,000 a year and contribute 10% of your salary to a traditional 401(k) and your company contributes up to 5% of your salary, you will end up with a total contribution on the year of $7,500.

Some companies are sneaky about how all of this works. For instance, some will not contribute more than their match percent on the paycheck total*. So if you are paid monthly, they would not contribute any more than their match percentage of your monthly paycheck total. In this case, you would need to contribute at minimum the match percent on every month throughout the year to ensure that you collect your matching benefit. This doesn’t seem like a big deal except for the impact of delaying investment throughout the year instead of front loading investments into a 401(k). So lets evaluate how significant that is.

*I would guess that companies do this to avoid paying the 401(k) match benefit to an employee that leaves anytime before the end of the year. Some companies will engage in a similar tactic called vesting. Some will also “true up” at the end of the year to account for any variability you may have had in your contributions throughout the year. The true up contribution is made at the end of the year if the employees contributions exceed the employers contribution up to the match percent on a years salary.

An additional benefit to front loading is that you minimize the risk that you lose the opportunity to utilize the tax advantaged space. At any point during the year you may decide to quit, lose your job, change jobs, or stop your income stream altogether. Minimizing the time spent with the account not fully utilized minimizes this risk. In short, by front loading you are making hay while the sun shines.


Setting the Stage for Comparison

Lets assume that you have access to an instrument that returns 5% annually in your 401(k). You plan to maximize the pre-tax contribution every year (we’ll assume it averages out to $20,000). Lets also assume the following:

  • In the front loaded case, you are able to max out the pre-tax contributions by May every year.
  • In the equal monthly case, you contribute equally every month to max out the pre-tax contributions.
  • The investment will compound continuously.
  • The investments will remain in the 5% instrument for the all durations listed below.

Front Loading Versus Equal Monthly Contribution Results

Front Load In Front Load Total Equal Monthly In Equal Monthly Total
January  $ 5,000.00  $   5,000.00  $ 1,666.67  $   1,666.67
February  $ 5,000.00  $ 10,020.88  $ 1,666.67  $   3,340.29
March  $ 5,000.00  $ 15,062.72  $ 1,666.67  $   5,020.91
April  $ 5,000.00  $ 20,125.61  $ 1,666.67  $   6,708.54
May  $ 0  $ 20,209.64  $ 1,666.67  $   8,403.21
June  $ 0  $ 20,294.02  $ 1,666.67  $ 10,104.97
July  $ 0  $ 20,378.76  $ 1,666.67  $ 11,813.83
August  $ 0  $ 20,463.85  $ 1,666.67  $ 13,529.82
September  $ 0  $ 20,549.29  $ 1,666.67  $ 15,252.98
October  $ 0  $ 20,635.09  $ 1,666.67  $ 16,983.33
November  $ 0  $ 20,721.25  $ 1,666.67  $ 18,720.91
December  $ 0  $ 20,807.77  $ 1,666.67  $ 20,465.74

The total difference after one year is $342.03. Considering that this extra $342.03 will continue to be invested in the 5% instrument here are the results after some longer durations:

Year  Additional  Total
10  $ 342.03  $   4,327.59
20  $ 342.03  $ 11,462.59
30  $ 342.03  $ 23,226.20

After 30 years, an extra $23,226.20 just because you timed your investments towards earlier in the year is nice. The more profitable the instrument, the more favorable the front loading (A 7% interest instrument would yield a $47,816.16 difference).

Now, what if your company is one of those that will only match up to the match percentage on the payment period instead of on the yearly salary and does not true up? An optimized solution is to front load as much as possible while still maintaining enough headroom in the account to catch the rest of the employer match until the end of the year.

I have placed an excel calculator that figures out exactly how to do that for you on the Wool Socks GitHub. Here is a screenshot taken directly from the calculator:

To use the calculator, edit the orange input cells, and review the employee column to see how to best front load the account while still capturing the employer match. You can see that in the screenshot above, with a salary of $50,000 and a 5% employer match, the employee can front load the account up until June, and then coast through to December only contributing enough to capture the match.

If you are expecting a raise in the year, it may be worthwhile to leave a little extra headroom in the account in order to accommodate the increased employer match after the raise. An example:

In the above screenshot, the employee may choose to contribute only $1,525.00 in June in order to leave a hundred dollars of headroom to account for a raise that may occur between July and December. If you plan to do this, don’t forget to set alarms for yourself to change contribution amounts at the correct times!

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