Friday, January 7, 2011

The BEST Piece of 401(k) Advice I've Read in a Long Time

If you search for articles which give 401(k) tips, you usually will get the standard pearls of wisdom:
  • Contribute at least enough to get the company match
  • Pick funds with low expenses
  • Invest for the long term
  • Periodically rebalance
  • Don't be tempted with withdraw the money
All of these pieces of advice are wise, but pretty much every advice article on 401(k) contains them.  It is rare that I come across 401(k) advice that is original.

Today is one of those days.

The website has an article entitled Financial Advice That Can Do Serious Damage.  Author Joe Mont quotes financial planner Robert J. DiQuollo who gives the following warning about how it is possible to miss out on one's full company match by having too high a deferral percentage:

Even if you have an above-average salary, is a bigger deferral rate necessarily better?

Choosing how much to contribute isn't always so simple.

"If you contribute too little to your 401(k), you may not get the full employer match," says Robert J. DiQuollo, president of Brinton Eaton, a New Jersey financial planning firm. "On the other hand, if you contribute too much, too fast, you can shortchange yourself."

DiQuollo uses the example of an executive making $20,000 a month who contributes 20% to a 401(k), with a 5% company match. He or she will reach the IRS' annual contribution limit of $16,500 in May and can't contribute for the rest of the year.

In this example, the executive gets a match of only $4,500 at a company that frontloads contributions. If the executive chose a 7% contribution rate instead, the $16,500 limit wouldn't be reached until December and would get the full company match of $12,000 -- or $7,500 more.

Honestly, this is something that has never crossed my mind, but it makes perfect sense.  If you max out your 401(k) contributions prior to your last paycheck, you are short changing yourself.  This concept doesn't just apply to highly compensated executives.  This is something that applies to anybody who is contributing the maximum of $16,500 to their 401(k) and gets a company match.  Anybody who intends to max out their contributions should make sure that they at least are contributing enough to get the full match in each and every paycheck. 

Of course, if you are not getting your company's full match, you are leaving free money on the table.  Most advice articles think in terms of making sure you contribute at least enough to get the full match.  Never have I come across an article which points out that you may be missing out on the full match by contributing too much too early in the year.

Serious kudos to Mr. Mont and Mr. DiQuollo!!!

1 comment:

  1. A lot of employers, mine included, take this into account and will match the maximum amount over the calendar year even if the employee front-loads contributions.