Two situations can prevent employees from getting the full amount of an employer's match money on contributions to their 401(k) or similar retirement plan. One is contributing too little to the plan—that is, contributing at less than the full rate that gets matched at least in part by their employer. The other is contributing too much to the plan—so much that they reach the annual federal limit on contributions before the last pay period of the year.
Although people might seem more likely to contribute too little rather than too much to their retirement plan, over-contributing does happen, often because plan participants are not fully aware of the annual limit. . In 2012, employee pre-tax or Roth contributions to 401(k), 403(b) and 457 workplace retirement plans are limited to $17,000. For plan participants age 50 or older by the end of 2012, total employee contributions are allowed to go as high as $22,500, which includes a $5,500 catch-up amount.
Too Much, Too Soon
In most cases, an employer match gets credited to a participant's plan account only when the participant contributes to the account as well. If participants reach the annual federal limit on contributions before the last pay period of the year, their ability to contribute to their account gets suspended until the start of the next year. When they stop contributing to their account, they stop receiving the employer match.
Consider this scenario:
Participants under age 50 are permitted to contribute up to $17,000 to their retirement plan in 2012. Let's assume that a participant's annual pay is $75,000 and that she gets paid $3,125 twice a month (or 24 times a year), she is participating in her retirement plan and her employer matches 50 percent of her contributions of up to 6 percent of pay (in this case, 6 percent of the participant's pay is $187.50 each pay period). So the full match will be $93.75 per pay period, or $2,250 per year.
At the start of 2012, to receive the full match for each of the 24 pay periods during the year, the participant needed to elect to contribute at least 6 percent of her pay to the retirement plan throughout the year and to make sure that her contributions do not get cut off before the last pay period of the year. If she had divided the $17,000 annual limit on contributions by 24 pay periods, she would have arrived at $708.33—the most she'd be able to contribute each pay period in 2012 and receive all employer match money to which she is entitled.
But let's assume that at the start of 2012 this participant decided to contribute $750 each pay period. She would have hit the $17,000 limit on contributions after pay period number 22, because $17,000 divided by $750 is a little over 22. Typically, she would not have been able to make any contributions to the plan for pay periods 23 and 24 of 2012.
Whether she had decided to contribute $708.33 or $750 per pay period, she would have ended up contributing the same $17,000 total during the year to the retirement plan. But if she had contributed $750 per pay period, she would have missed out on getting the $63 employer match for each of the last two pay periods of the year. In other words, she would have forfeited $126 in matching contributions in 2012.
Some options might be available for participants who hit the federal contribution limit prior to year-end. For instance, some employers offer a "true-up" match to credit a retirement plan participant's account for any match contributions he or she missed receiving that are attributable to hitting the annual limit on employee contributions.
Another alternative for individuals looking to contribute more than the $17,000 annual contribution limit is to make additional after-tax contributions to their pretax 401(k) plan.
The total limit on employee contributions made to a pretax-contribution or "traditional" 401(k) or to a post-tax-contribution Roth 401(k), in whatever combination, remains $17,000 for 2012, excluding catch-up amounts. Taxes are owed on distributions taken during retirement from a pretax 401(k), but no taxes are owed on distributions from a post-tax Roth 401(k).
However, assuming that the employer's plan allows for after-tax contributions to a traditional 401(k), employees are able to make contributions over the $17,000 limit by using this feature. While after-tax contributions do not receive an up-front tax deduction going into the plan and taxes will be owed on distributions, the money that is earned on these contributions will grow on a tax-deferred basis.
There are additional Internal Revenue Service limits to be aware of in terms of the maximum amount that can go into a plan that includes employee pretax contributions, employee after-tax contributions and employer contributions. The annual limit for 2012 from all sources is $50,000; however, employers may put in place their own plan limits in terms of the percent of an employee’s pay that can be deferred into the plan. So while the IRS limit is $50,000, plan limits may prevent a participant from getting the full $50,000 into the plan in a year.
A Daunting Task
Navigating the landscape between IRS and employer plan limits can be a difficult task for many, and when coupled with other difficult decisions—such as whether to use a Roth individual retirement account (IRA) vs. using after-tax retirement contributions to a traditional 401(k)—it can make the task even more daunting. This is just one example of why it is becoming increasingly important to provide employees with financial education and guidance.
Thomas DiLorenzo, a manager in Ernst & Young’s Employee Financial Services group, provides personal financial planning services and financial education to employees of large companies. He holds a B.S. in business economics and the Certified Financial Planner and Enrolled Agent designations.
The views expressed herein are those of the author and do not necessarily reflect the view of Ernst & Young LLP. © 2012, Ernst & Young LLP.
IRS on How 401(k) Administration Is Affected by Excess Compensation, Thompson's SmartHR Manager, April 2012
For 2012, IRS Raises Plan Contribution Limits, SHRM Online Benefits Discipline, updated November 2011
The Roth 401(k): A 'Value Add' for Your Employees, SHRM Online Benefits Discipline, updated January 2012
Stretch 401(k) Match Forumulas to Boost Participation. Tweaking plan design and matching formulas can promote greater employee participation, says Greg Burrows, senior vice president at The Principal Retirement Group.
SHRM Online Benefits Discipline
SHRM Online Retirement Plans Resource Page