Retirement Accounts: Two Ways to Miss Out on Your Employer Match

If you spend much time perusing personal finance advice, you’ve probably come across the recommendation to contribute to an employer-sponsored retirement account (usually a 401k or 403b) so you maximize your employer’s matching contribution. For most of us, that just means contributing at least up to the point that our employers would stop matching our contributions; we only need to worry about missing out on our employer’s matching funds if we contribute too little toward our retirement.

It was a couple of years ago that I was informed that there was another way to miss out on the extra retirement contributions that come from our employers: maxing out on the annual contribution limit too quickly.

To be clear, I am not saying that you should not max out on your annual contributions to these types of accounts (for 2021, $19,500 if under age 50; $25,000 if age 50+). And, if missing out on an employer match because you’re putting money in too quickly is a concern for you, then you’re probably winning the personal finance game…possibly in lopsided fashion.

Still, I felt compelled to finally math out both ways we can miss out on the extra retirement contributions that come from our employers.

Method 1: Contributing Too Little

We’ll start here because it probably affects more people. The math is also a lot easier, and you can see the impact right away. I’ll use the structure of my employer as an example; the employer match is set up in two tiers:

  • Tier 1: 100% match for the first 3% of my income contributed to my 401k.
  • Tier 2: 50% match for the next 2%, or up to 5%, of my income contributed to my 401k.

Based on this, I want to contribute at least 5% of my income to my 401k to maximize the match; if I contribute any less than that, I miss out on that employer-supplied money. For example, if my salary is $100,000 per year and I get paid every other week ($3,846.15 per pay period), some of my contribution rates might look like this:

Fig 1: Contributing up to my employer’s maximum match compared to some lower contribution rates.

The impact of contributing less than 5% would be felt immediately. If I contribute less than 5%, below where my employer will match my contributions, I miss out on some retirement savings.

Method 2: Maxing Out Too Quickly

The other way to miss out on an employer match is a lot less obvious because it doesn’t affect employees until they’ve effectively won the income game and it won’t become apparent that you’re missing out on the employer match right away.

This Doesn’t Affect Many People

First, let’s look at how much of a contribution someone would need to make in order to max out on their 401k contributions for 2021. One common recommendation for a contribution rate to a 401k/403b account is 15% of your income. Looking at the figure below, we see that someone under the age of 50 would need to earn $130,000 in 2021 to max out their contributions for the year while contributing 15% of each paycheck; they would need to earn a little over $170,000 if age 50 or over, due to the catch-up provision adding $6,500 to the maximum contribution amount.

Fig 2: How much you would need to contribute to an employer-sponsored retirement account to max out in 2021 at different income levels.

At the lower end of the income chart, the contribution rates needed to max out these retirement accounts become quite difficult, if not impossible, for the average person to pull off. Given that the median household income in America in 2020 was $68,400, you can see how few people would run into this second way to miss out on an employer match in their retirement accounts ($19,500 / $68,400 = 28.5%; w/ catch up provision: $25,000 / $68,400 = 36.5%).

If it Could Affect You, it Takes a While to Notice

Now that we’ve seen how much it takes just to max out a 401k, let’s look at the impact of maxing out earlier than your last paycheck of the year. For this, we’ll keep the matching structure of my current employer (100% match on 1-3% of income + 50% match on 4-5% of income) and a $100,000 annual salary for two hypothetical employees who are both under the age of 50.

Our first employee, Employee 1, contributes 19% to their 401k, which is not quite enough to fully max out. Employee 2, however, decides to max out a little early in the year and contributes at a rate of 25%. How does each employee do?

Fig 3: Employee 1 contributes on every paycheck; Employee 2 maxes out early.

As the chart above shows, everything starts off fine, and both employees are enjoying a full employer match for the first 21 paychecks. Both employees continue to get the maximum amount of employer-sponsored funds until we get to the 22nd pay period, at which time Employee 2 has already hit the annual max and no longer contributes his own money to the account. No employee money means there is nothing for the employer to match, so the matching dollars also go to zero.

When we get to the end of the year, Employee 1 has added more to their retirement account despite having contributed $500 less of their own money, $23,000.12 vs $22,730.85 for Employee 2.

What does that mean for Employee 2?

It would take a relatively stable investment return over the course of the year of a little more than 11% for Employee 2 to catch up to Employee 1 for the current year. To also get their $500 back on top of that, since Employee 1 only contributed $19,000.02 of their own money instead of maxing out to $19,500, the investment return would need to be around 29.6%, again assuming a relatively constant rate of growth throughout the year. (I’m also assuming that both employees invest in the same funds within the account.)

And, the “Method 2” Conclusion is…

While there’s nothing wrong with maxing out your annual 401k contribution, you do want to be strategic about how quickly you max out each year. You can use figure 2 above to estimate what the ideal % of your income to contribute is.

If you are blessed enough to have a little extra money to invest even after maxing out on your employer-sponsored retirement account, or if you want to divert your investment dollars elsewhere prior to reaching that point, it’s OK to focus on some other tax-advantaged investment accounts that might fit your needs (a good fiduciary financial advisor can probably help you out there). Personally, I am only at a 12% contribution rate, and also focus on maxing out contributions to a Roth IRA. I get the full employer match as long as I contribute more than 5% and don’t venture too deep into the 20s.

Also note that our fictitious Employee 1 would still maximize their employer match by contributing 20% of their income. The withholding for each paycheck would be $769.23 until the final pay period, when only $269.25 would be withheld…still enough to get the full $153.85 match from the employer.

And, if this second scenario doesn’t impact you in the here and now, hopefully I’ve given you something to keep in mind as your income increases over the course of your career.

Hope you enjoyed this post. Thank you for reading.

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