Should You Max Out Your 401k Early in the Year?

Maxing out your 401k early in the year can cost you a lot of money if you have an employer match. Without the match, front loading your 401k is worth considering.

It’s common financial advice to max out a 401k. Putting as much away in a tax advantaged account as possible is just smart financial planning. There is, of course, a limit to how much we can contribute each year to a workplace retirement plan. And that has some asking whether they should max out their 401k as quickly as possible or spread out the contributions throughout the year.

The question was first posed to me by a reader named Stu:

Been listening to your podcast for the last few months and have really been enjoying it.

I wound up maxing out my 401k before the end of the year and that got me wondering if there is any advantage (or disadvantage) to maxing it out as early in the year as possible to take advantage of compounding. The rationale being that the sooner you get the money in there, the more chance it has to grow. Probably a simple excel calculation, but not simple enough for me.

Cheers,

Stu

There is an annual limit to 401k contributions. In 2018, the limit was $18,500 plus an additional $6,000 for those 50 or older. In 2019 the limit increased to $19,000 plus an additional $6,000 for those 50 or older.

How quickly you reach these limits each year is largely up to you. With my current 401k, for example, I can choose what percentage of my income to contribute with each paycheck, up to a maximum of 75%. For those that have the income to reach the 401k contribution limit early in the year, Stu wants to know if that’s a good idea. The theory is that the sooner you put your money to work in the market, the better.

Stu’s question may seem simple at first glance, but it touches on several nuanced issues related to retirement savings: (1) should you max out your 401k at all, (2) should an employer match–for those that have one–affect the decision, and finally (3) Stu’s question related to the benefits of investing as early in the year as possible.

Let’s look at each of these issues.

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1. Should you max out your 401(k) at all?

Maxing out a 401(k) is not always the best decision. While some workplace retirement accounts of good investment options, many are loaded down with expensive and market underperforming mutual funds. In contrast, with an IRA we get to choose where to open the account, giving us unlimited investment options.

With that in mind, here’s a strategy to consider:

Step 1: Start by funding your 401(k) up to the employer match. If your employer has a 401(k) matching contribution, you should contribute enough to take full advantage of that match. If your employer offers to match your contributions dollar for dollar up to 6% of your pay, for example, then your first priority should be to take full advantage of that match. After all, it’s virtually free money.

You can also go a step further by making sure your 401(k) is properly managed. Thankfully, there’s a robo-advisor that can do the job and affordably. blooom is the only dedicated robo-advisor for 401(k) accounts. With blooom, you can get a free analysis of your retirement plan and for $10 a month, blooom will manage your 401(k). This includes regularly adjusting your portfolio and expert financial help from blooom advisors. blooom can also alert you to hidden fees you may be paying, saving you money. blooom can work with any employer sponsored retirement plan and is currently the only robo-advisor available that specifically manages 401(k) accounts.

Step 2: Max out your IRA contribution – traditional or Roth. Because you choose where and what to invest in with an IRA, you generally get better investment options in an IRA than in the typical 401(k) plan (the government’s TSA is one exception to this rule.).

My top choices for a broker for your IRA are Vanguard and Betterment. I lean toward Betterment because once you reach $100,000, the management fee drops 15 basis points. Wealthfront is another good platform, but the management fee is 25 basis points. (However, I favor Wealthfront for taxable accounts because it provides unique tax loss harvesting capabilities.)

Step 3: Max out your 401(k) if you have the money.

For 2019 that’s $19,000.

I assume from Stu’s question that he has the money to do all of this. So let’s move the second issue, the employer match.

2. Employer Match

The employer match warrants special consideration. Contributing early could cost you big in the form of a reduced match.

To keep the numbers round, let’s say that you earn $100,000 per year, and that your employer matches your contributions, dollar for dollar, for up to 6% of your salary. That means that the match has a potential benefit of $6,000.

Now let’s assume you contribute exactly 6% throughout the year. At the end of the year you will have contributed $6,000 (6% of $100,000) and your employer will have matched this amount. To max out your contributions in equal amounts throughout the year, you would contribute 19% each pay period (19% of $100,000 is $19,000, the 401k limit for 2019). Each pay period your employer would contribute its 6%, for a total of $6,000.

But what happens to the employer match if you contribute more than 19% each pay period? Let’s look at an extreme example of contributing 50% of your pay. Your monthly gross income in our example is $8,333 ($100k / 12). A 50% contribution would mean adding $4,166 per month to your 401k. The result would be that you would reach your contribution limit in about 4.5 months ($19,000 / $4,166 = 4.56 months).

Now remember, you’re employer will match your contributions up to 6% of your gross pay, which comes to $500 a month ($8,333 x 6%). It will take you just 4.5 months to reach your maximum contribution of $19,000, after which the employer match will stop because your contributions will stop. That works out to approximately $2,250 ($500 X 4.5 months), rather than the $6,000 that the employer would match over the course of the year.

Not all employer matching programs work this way, but this is how it worked at my last employer. Some employers will complete the match based on your year-end income, but not all. You should find out about this from your 401(k) plan administrator, at least if you plan to max out your 401(k) early in the year.

3. What about the market?

This gets down to the question of lump sum investing versus dollar cost averaging. You can get a more complete discussion of my views on this topic in Podcast 71 which is completely dedicated to the topic. But let’s summarize it here.

Under ideal circumstances, lump sum buying works well if you can buy into the market at the point of the year when stocks are the cheapest. The problem is that we can’t know when that’s going to be. The market goes up in the long term, so in theory at least, the earlier that you get into the market the better. And of course, you want to take advantage of both tax deferral and of compounding of investment returns, too.

Over the long-term, it will probably be to your advantage to front-load funding. Lump sum investing tends to outperform dollar cost averaging, at least in many years.

In 2013 for example, front loading would have worked well because the market ultimately rose 32% for the year. But had you done it in the 2008 – 2009 time frame, it would have been a disaster because the market fell from the beginning of each year.

I think the bigger question in regard to front-loading is how much does it really matter? And I think the answer to that question is, probably not much. I tend to max out my 401k early, but not to the extreme. One year, I maxed out my 401k (which doesn’t have an employer match) in about nine months.

Do you have different thoughts on maxing out your 401(k) early?

Next Steps

Topics: PodcastRetirement Planning

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15 Responses to “Should You Max Out Your 401k Early in the Year?”

  1. Axel Bishop

    Just puzzling over these questions and landed on your insightful commentary. Here’s a twist – I’m retiring July 1. I’m going to push the percent contribution to my 403b (non-profit employer version of 401k) so that I hit the $25,000 dollar limit before I retire. I won’t be getting the match for the rest of the year anyhow, so deferring all the tax I can makes sense to me. I’ve got cash accounts with plenty of income to live off, which is being taxed anyhow, so why not defer tax on salary? Other considerations (quality of investment choices in the 403b, e.g, are not a problem). What do you think?

  2. Aby Ayanbule

    Thanks so much for this information. I just called Fidelity to find out if i get a true-up match based on my front loading and i was told that yes i do, but payouts dont happen till Q2 of the following year!!! Based on this, I immediately changed my contribution %. That way I get my employer match in same year. Thanks so much! Very informative.

  3. Check you tax outcome as if you front load and then leave the firm, you would be setting up for a good chunk of tax free wealth building in the near term while your tax rates are high vs in retirement where in theory they should be far lower as you plan to decrease earned and annual expenses.

  4. Hi Paul,

    My company contributes 6% of gross pay. If I think I will be leaving my company at the end of April 2017 which scenario is better? I assume I will have a waiting period at another company and not get any contributions in 2017. (Mine or the company).

    Looking at even annual withdrawals on my side I will have contributed $6,000 and my employer will have put in $2,640. Total is $8,640.

    If I contribute all $18K in those 4 months, the employer will still have put in $2,640 so total is $20,640 in my 401K versus $8,640.

    The market is high now and I am not sure if I will leave the company but I’m almost positive I won’t be at this company at the end of 2017. Please advise your thoughts – thanks!

  5. Our company does not have limit of 6%, but matches only 40% (i.e. 40cents per dollar). I tend to max out my 401k in 4 or 5 months literally taking home no salary and in process getting matching funds(no conditions) as well maxed out.
    Have setup the 50% of future contributions in my 401k to few retirement funds and the rest goes into my stable value fund. Every month i monitor my fund and move funds from my stable value fund to funds of my choice. Also when there is a big dip in market I just go in and push some funds into the choice of funds.
    Hopefully my investing will compound to a certain extent, which is my guess.
    Agree that in the scenario 2008/2009 it would have negative impact, need to watch out for such things though.
    For e.g. when PIMCO fund manager move out news came, i jumped and moved most almost 90% of the funds to a stable fund (was really lucky in this scenario).

  6. Maura Lyn

    Hope you can help me understand this. I received a letter today March 2015 that I received a contribution plus earnings in my company savings plan for matching contributions. I called the plan administrator who checked and said it is a true-up contribution — however, my company doesn’t match my 401k so I’m confused. They said it isn’t an error. They mentioned it is from Q1 2014 and based on the year prior. I believe my employer ended our 401k match in Jan 2012, possibly 2013. Any idea what this could be?

  7. Meridith

    Informative show, as always. Regarding Morningstar: It’s worth checking your local library’s website to see what databases are available. If your public library’s electronic resources are lacking you can often access content from your state library; or if you’re a college student or alumni, your university library. In addition to Morningstar, Factiva, LexisNexis, Business Insights (Gale), and Business Source Premier (EBSCO) are great resources for business and investing information.

  8. Rob,

    I totally agree with the plan that you outlined. First, I save enough to achieve the company match in the first 2-3 months of the year. Who knows what will happen to my place of employment? So I want to make sure to collect that $6k cash-ola contribution as quickly as possible. My company matches 50% up to $6k whenever you save it. So, if you can save 75% of your salary in January, and the match that you earn equals $6k, then you keep the $6k in January. If I were Daddy Warbucks, that is exactly how I would roll! In March, I work on saving my Roth IRA contribution for the previous year. And during the subsequent months, I return to saving in my 401K until I hit the maximum. Needless to say, I look forward to relaxing on my savings in the late summer and fall, and especially appreciate the months when I am not focused on retirement savings and also have crossed over the social security with-holding max threshold.

    Keep up the good work. I love, love, love your podcast.

  9. I think you’ve covered most of it. The biggest issue would be if your employer does not give a “true up” match. If your employer provides true-up match, then there is no disadvantage in front-loading the contribution, assuming you can afford to do it.

    The other reason to not front-load would be if your employer 401K does not have very good fund options (i.e. high expense ratio funds). Rather than putting 18K in the first few months, it would make sense to rather DCA your contribution so you can invest your savings in a taxable account or IRA with better fund options which are likely to perform better.

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