If your employer offers a 401(k) plan, you probably know that one of the best ways to save for retirement is to max out your contributions each year. In 2022, for example, you can defer up to $20,500 in pretax salary to a 401(k) plan ($27,000 if you’re 50 or older). And if your employer offers matching contributions, you probably also understand the benefits of contributing at least enough to qualify for the maximum employer match. If you don’t, you’re leaving free money on the table.
What you may not know is that the timing of your contributions can have an impact on your eligibility for matching contributions. For example, if you “front-load” contributions — that is, max them out early in the year rather than spread them evenly over the entire year — you risk losing a significant amount of matching contributions, depending on the terms of your plan.
If your plan allows it, front-loading can be a smart investment strategy because the markets generally appreciate in value over time. So, the earlier you contribute to a retirement plan, the more time those funds are in the market, thus creating the possibility of greater returns in the long run.
Of course, when it comes to investing there are no guarantees, and there are times when the markets go down. If you max out your 401(k) contributions by the end of April and the market crashes in June, you may discover that your returns for that year are lower than if you’d spread your contributions over the year.
Despite this risk, people who front-load their contributions tend to enjoy greater long-term returns. But front-loading can backfire — in dramatic fashion — if your employer matches contributions based on your compensation each pay period rather than your annual salary.
Maximizing matching contributions
The employer match is a powerful tool for boosting the returns on your 401(k) account. But the method of determining matching contributions can vary significantly from plan to plan. A common approach is to match contributions up to a certain percentage of your compensation for each pay period.
Under this approach, front-loading contributions may cause you to miss out on a substantial amount of free money. Here’s an example:
Michelle’s salary is $240,000 per year, paid over 24 pay periods ($10,000 per pay period). She front-loads her 401(k) contributions, deferring 20% of her salary, or $2,000 per pay period. Her employer offers dollar-for-dollar matching contributions, up to 5% of income — in this case, $500 — in each pay period.
In 2022, Michelle reaches the $20,500 contribution limit by her 11th paycheck in the middle of June, with matching contributions totaling $5,500. Because Michelle has maxed out her contributions, she stops making contributions in mid-June, and receives no matching contributions for the rest of the year.
Suppose, instead, that Michelle deferred 9% of her salary ($900 per pay period) to the 401(k) plan. In that case, she wouldn’t reach the contribution limit until her 23rd paycheck in mid-December, and would receive $11,500 (23 x $500) in matching contributions. That’s an additional $6,000 in pretax contributions each year, plus tax-deferred earnings on those amounts. That can give your retirement nest egg a significant boost over 10 or 20 years. In most cases, these additional savings will eclipse the benefits of front-loading contributions.
Know your plan
To make the most of your 401(k) contributions, be sure to understand your plan’s terms. If matching contributions are determined for each pay period, then front-loading will likely cost you money. But if your plan allows you to receive a match based on your contributions for the year, then front-loading may provide an advantage.