Meet Henry and Sandra, a couple in their late 30s:
They both have established careers and enjoy their high-earning jobs, which they use to support their two young children, ages five and three. With automatic monthly contributions to their retirement fund, Henry and Sandra think they’re prepared for the future and taking full advantage of those employer-sponsored 401(k) plans – but are they really?
Simple retirement planning mistakes can drastically impact future income. Let’s take a closer look at what we can learn from Henry and Sandra’s three 401(k) mishaps (and what you should do instead).
Mistake #1: Not Contributing the Maximum Amount
Henry earns $150,000 and contributes 5% of his salary each year to receive the 100% match offered by his employer. But just because his employer stops contributing at $7,500 doesn’t mean Henry has to, as well!
In fact, Henry is eligible to make $22,500 in 401(k) contributions in 2023. By sticking to that employer matching maximum, he’s left $15,000 of tax advantaged contributions on the table.
(Fun fact: Those aged 50 or older in 2023 can enjoy a maximum contribution of $30,000!).
What you should do: Make sure you’re contributing the maximum amount to your 401(k) each year, even if it surpasses your company match.
Mistake #2: Reaching Contribution Limits Too Early
Employer matching is a great opportunity to gain free retirement savings. Sandra planned to contribute 20% of her $112,500 base salary to her 401(k) this year. To check that off her financial planning list, she made those contributions early.
Fortunately, Sandra’s company had amazing success in 2022 and decided to pay her a one-time $100,000 bonus. While this extra income was a great surprise, it also represented a missed opportunity for maximizing employer match contributions. Sandra’s 401(k) limit was already reached, and even though her company match accrues proportionally throughout the year, she was out of the game.
What you should do: If your company match accrues throughout the year and there’s a chance of more income coming your way, spread out those contributions. There’s no penalty for making the contributions later on in the year as opposed to during the early months!
Mistake #3: Not Benefitting From Roth Contributions
Did you know that many 401(k) plans offer Roth contributions?
These are known as Roth 401(k)s, and they allow you to combine features of a traditional employer-sponsored plan and a Roth IRA for more flexibility in your planning.
While Henry’s plan included the opportunity for Roth contributions, he was living by the conventional wisdom: You should only use a Roth contribution if you expect your tax rate to be lower in retirement.
But how can you possibly know what your tax rate is going to be in retirement?
We have seen good savers experience the highest tax rates in their later years when Uncle Sam requires distributions from tax-deferred retirement accounts. In Henry’s case, optimizing his funds wasn’t as straightforward as he thought.
What you should do: The pros and cons of your contribution options are beyond the scope of this article, but we generally prefer to see clients fill the Traditional (pre-tax) and Roth (after-tax) buckets for maximum optionality. That being said, the ultimate answer depends entirely on your individual situation, so we’d recommend sitting down with your advisor.
Henry and Sandra have all the tools they need to save up for retirement. With the right knowledge and experts on their side, they could make even more of their 401(k) contributions. If you’re interested in optimizing your retirement contributions, it’s a great idea to meet with a financial professional and get started today.