Key Points:
- 2024 Contribution Limits: Maximum $23,000 contribution, plus $7,500 catch-up for those over 50.
- Strategic Employer Matching: Distribute contributions evenly to maximize employer matching throughout the year.
- 401(a)(17) Income Cap: Use the $345,000 cap for calculating contributions to ensure full employer matching for high earners.
- Accurate Contribution Calculations: Correct calculations can lead to substantial tax savings and increased retirement funds.
- Comprehensive Planning: Embrace strategies like backdoor Roth IRAs and after-tax contributions for optimal 401K growth.
Introduction
As the year wraps up, it’s time to start thinking about next year. One of the most time-honored traditions of savers to start the new year is to calculate the 401K withholding percentage needed to max out your 401K for the new year.
The calculation is usually simple: take the new IRS 401K employee contribution maximum in 2024, which is $23,000 (plus an additional $7,500 if you are over 50), and divide that by your annual total compensation. Assuming you are under 50 and your total compensation is $450,000, you will update your 401K withholding amount to 5.11% to maximize your contribution and deduction.
The first question you might ask is, why not just increase the amount to a higher amount, say 10%? I would max out early in the year, but who cares? My checks will be bigger at the end of the year!
Issue #1: Employer Matching Ends
Well, going with a high contribution percentage might work out for you, but you could also be leaving thousands of dollars on the table if you haven’t read your 401K plan documents. Many plans, including my former employer RPM Inc., match per paycheck when the employee contributes. If you max out early in the year, you’ll miss out on matching contributions. Below is a simplified example of both situations for an employee making $250,000. In the first example, the employee chose to contribute the calculated total evenly across the entire year ($23K / $250K = 9.20%). They decided to go big early in the second example, contributing 20%.
9.20%20.00%MonthSalary401K Employee401K
Match401K Employee401K
MatchJanuary$20,833.33$1,916.67$833.33$4,166.67$833.33February$20,833.33$1,916.67$833.33$4,166.67$833.33March$20,833.33$1,916.67$833.33$4,166.67$833.33April$20,833.33$1,916.67$833.33$4,166.67$833.33May$20,833.33$1,916.67$833.33$4,166.67$833.33June$20,833.33$1,916.67$833.33$2,166.67$833.33July$20,833.33$1,916.67$833.3300August$20,833.33$1,916.67$833.3300September$20,833.33$1,916.67$833.3300October$20,833.33$1,916.67$833.3300November$20,833.33$1,916.67$833.3300December$20,833.33$1,916.67$833.3300Totals$250,000.00$23,000.00$10,000.00$23,000.00$5,000.00
In this example, the employee lost $5,000 in one year of company match by not reading the plan rules! That’s free money lost.
I’m not proud to say this, but I fell prey to this exact situation in my first year with RPM Inc. Don’t be like 24-year-old me; read your plan document or ask HR exactly how your plan operates.
Issue #2: Understanding the 2024 401(k) Income Limits
The 401(a)(17) contribution limit is even less known than the discussed matching issue. This regulation can impact the ability of highly paid corporate professionals to fully leverage their 401(k) contributions. In 2024, this rule caps the employee compensation considered for employer 401(k) contributions to the first $345,000 of income. This means that for incomes exceeding $345,000, your employer cannot make matching employer contributions.
How Does This Affect You? An Example from Our Practice
Consider an executive at a leading marketing firm in New York City with an annual income of $700,000, including bonuses. He aims to contribute the maximum to his 401(k) in 2024, which is $23,000, plus a catch-up amount of $7,500, as he is over 50. However, he is unaware of the 401(a)(17) limit and its implications.
He calculated his contribution as a percentage of his total compensation, 4.50% ($31.5K / $700K), expecting to reach the maximum by year-end. However, after his combined salary and bonus exceeded $345,000, further contributions from his employer ceased. The impact should be minimal if you contribute enough to get the match every month. The more costly issue is that, in some cases, the employer will also not allow the employee to make contributions after exceeding the IRS cap. It makes record-keeping easier for them, making it more common than it should be.
Fortunately, if you are aware of this issue before the year starts, the fix is simple. When calculating the year’s 401K contribution percentage, use the cap number instead of your actual salary. In our example above, that would be the total amount we want to contribute: $31.5K ($23K normal + $7.5K catch-up) divided by the cap number of $345K for a contribution rate of 9.13%.
Now look at the impact of this:
4.36%9.13%MonthSalary401K Employee401K
Match401K Employee401K
MatchJanuary$58,333.33$2,543.33$2,333.33$5,326.09$2,333.33February$58,333.33$2,541.67$2,333.33$5,326.09$2,333.33March$58,333.33$2,541.67$2,333.33$5,326.09$2,333.33April$58,333.33$2,541.67$2,333.33$5,326.09$2,333.33May$58,333.33$2,541.67$2,333.33$5,326.09$2,333.33June$58,333.33$2,325.33$2,133.33$4,869.57$2,133.33July$58,333.3300August$58,333.3300September$58,333.3300October$58,333.3300November$58,333.3300December$58,333.3300Totals$700,000.00$15,035.33$13,800.00$31,500.00$13,800.00
By making that simple change, pre-tax contributions were increased by $16,435, resulting in a tax savings of $6,081 (at the 37% rate). This is a costly mistake for high-earning W2 corporate employees, where tax breaks are hard to come by.
Considerations for After-Tax and Roth Contributions
These limits also apply to Roth 401(k) contributions and non-Roth after-tax contributions. If you’re aiming to maximize these, calculate and contribute before hitting the income limit.
Maximizing Employer Contributions Under the 2024 Limits
Many companies offer alternative plans to continue contributions once the standard 401(k) limit is reached. For example, a firm might redirect contributions to a non-qualified plan, which, while beneficial, has its nuances and restrictions. Understanding these options is key to maximizing retirement savings and tax efficiencies.
Our Approach to Maximizing Your 401(k) Contributions
At Purpose Built, we believe in proactive financial planning. Our annual reviews with clients include an in-depth analysis of compensation and benefit plans. We guide you in optimizing contributions to ensure you’re on track for a successful retirement, considering all avenues like backdoor Roth IRAs and after-tax roll-outs.
Frequently Asked Questions (FAQ)
Q: What is the maximum employee contribution for 401K in 2024?
A: In 2024, the maximum employee contribution for 401K is $23,000. If you are over 50, there is an additional catch-up amount of $7,500.
Q: How does employer matching affect my 401K contributions?
A: Employer matching is often calculated per paycheck. If you max out your 401K early in the year, you might miss out on subsequent matching contributions, potentially losing thousands of dollars.
Q: What is the 401(a)(17) contribution limit and how does it impact high earners?
A: The 401(a)(17) limit caps the employee compensation considered for employer 401K contributions at $345,000 in 2024. Incomes exceeding this limit will not receive employer matching contributions.
Q: How should I calculate my 401K contributions to maximize benefits?
A: To maximize benefits, calculate your contribution percentage based on the 401(a)(17) income cap rather than your total salary. This ensures you receive maximum employer contributions throughout the year.
Q: Are there any considerations for after-tax and Roth 401K contributions?
A: Yes, the 401(a)(17) limits also apply to Roth 401K contributions and non-Roth after-tax contributions. It’s crucial to calculate and contribute before hitting the income limit to maximize these contributions.
If you have any questions about tax planning, are unsure if you are maximizing your 401(k), or want to explore how a Flat-Rate Fee-Only structure can help you achieve your goals, set up a time to talk.
Your financial well-being is too important to leave to chance. Choose wisely.
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