At the end of the year, most people in the United States are thinking about the holidays and the potential credit card bills for gifts and family visits. One good way to control this potentially stressful month is to take some time to breathe and get your own finances in order. There are several actions you should consider and complete before the year ends in order to start next year on the best foot possible.
A few weeks ago, the IRS announced that the 2017 individual contribution limit toward a 401(k) retirement account will remain unchanged from 2016. Anyone financially comfortable enough to maximize the contribution will be able to tuck away $18,000 this upcoming year (the same as they could this past year). Savers aged 50 or older qualify for an extra $6,000, in addition to the $18,000, for a total contribution limit of $24,000.
If you plan to maximize your contribution, and did so this past year, you don’t need to make any changes. However, if you didn’t reach the contribution limit this year but plan to do so in 2017, take some time now to plan.
Contact your benefits department via phone or website and change your deductions for the upcoming year. The changes could take a few weeks to go into effect. If you want the increased contributions to take effect at the beginning of the year, it’s best to start looking at the details now.
Calculate Based on Employer Match
In many cases, employers offer some sort of matching contribution. For example, the company might match half of your contributions, up to the first 6% of your salary that you contribute. Or, perhaps they’ll match all of your contributions up to the first 3% of your salary.
Let’s take the first case. In order to maximize your tax benefit and matching benefit, you’ll need to deduct 6% of your paycheck every period, if 6% of your annual salary adds up to $17,000 or less ($22,500 or less if you’re 50+ years old). In the second case, you’ll only need to deduct 3% of each paycheck. If the optimal percentage would result in exceeding the government-mandated maximum, you’d have to determine the best percentage that prevents you from exceeding that threshold.
I found out recently that some employers offer a benefit, sometimes called something like “spillover protection.” Let’s say you contribute more than the IRS maximum. Companies that offer this feature will allow you to continue deferring income to your 401(k); it would just be considered after-tax contributions. Most other employers would just automatically stop your contribution once you hit the limit. So why is this a nice benefit to have? Well, for those whose deferments automatically stop, and whose employer matches contributions on a per-paycheck basis, they’ll miss out on some matching contributions. Essentially, they’re giving up free money. With this spillover protection, their employer will continue contributing their match (the free money) up to the limit, versus leaving it on the table.
Employers may also have other contribution limits. It’s common for a corporation to say that the maximum contribution percentage is 50% of an annual salary. Be sure to check into your benefits and plan out the year’s contributions accordingly.
Not Maxing Out Contributions This Year?
Recalculating the 401(k) contribution at the end of the year is not a tactic just for those earning enough to maximize the tax benefit. Let’s say you received a raise or cost of living increase this year and haven’t adjusted your 401(k) deferment to match the extra cash flow. The end of the year is a good time to bump your contribution by one or two percentage points. Some 401(k) plans have options where the investor can initiate automatic investment increases each year. This is a good opportunity to turn this feature on or manually adjust your contribution.
This advice also isn’t just for people working for large corporations. Non-profit organizations often offer similar benefits called 403(b) plans, and if you’re self-employed, you may save for your retirement using an individual (or Solo) 401(k) plan.
Don’t wait. The process of changing your contribution can take a few weeks to take effect, so if you want to contribute a consistent percentage of your income throughout the new year, the sooner you make the change, the easier that will be.
Updated December 10, 2016 and originally published December 6, 2016.