free money | company matching contributions

It’s bonus time – Are you accidentally giving up free money?

Every year, we come across people who have accidentally forgone the company matching on their 401k, essentially free money, due to their contribution elections. Could you be one of these people missing out on your company matching contributions? And if so, how do you avoid this mistake in the future?

Understand how your company matching works

Your employer has quite a bit of leeway when designing the retirement plan and determining how (or if) they will match your contributions. One of the important factors is whether your company matches contributions on all compensation or only on specific types of compensation. For instance, a company may provide matching contributions on base salary but not on bonus or incentive compensation. 

And, does your employer provide matching contributions on all types of employee deferrals or only certain types? For example, does the employer match Roth 401k contributions and non-Roth after-tax contributions as well as pre-tax contributions?

Also, it’s important to note that this discussion does not pertain to profit-sharing contributions or safe-harbor contributions by the employer. Those contributions are not related to the amount that you contribute to your 401k.

Understand the annual contribution limits

The IRS sets limits for the total amount you can contribute to your 401k each year.

First, there is a limit to what an individual can defer in their 401k. In 2024, an employee can defer up to $23,000 ($30,500 if they’re at least 50 years old by the end of the year) between their Roth and their pre-tax contributions. However, in total, including any additional non-Roth after-tax contributions and employer contributions, the amount contributed for 2024 cannot exceed $69,000 ($76,500 if the employee is at least 50 years old).

In addition, the maximum amount of compensation that can be considered for matching contribution calculations is $345,000. There are also additional limits and formulas that apply to employees who are considered Highly Compensated Employees.

Does your bonus affect your matching contributions?

When you consider the employer’s matching policy together with annual contribution limits, you may end up leaving free money on the table. Here are the factors to consider:

  1. Will you max out for the year due to your bonus?

    If you keep your regular deferral percentage in effect for your bonus, will your personal contributions cause you to meet the maximum deferral amount before the end of the year?

  2. Does your employer consider your bonus when matching?

    If you contribute to your 401k from your bonus, will your employer match the amount that you contribute from your bonus?

If your employer does not match contributions that you make from your bonus, there is the potential for you to reach the maximum annual contribution amount with non-matched contributions by contributing from your bonus.

Here’s an example. Let’s say that your base compensation is $250,000, and your bonus is an additional $250,000, payable in February. Assume you are contributing 7% of your pay to your 401k and you are 45 years old. You have contributed $1500 to your retirement plan for the year prior to receiving your bonus. When you receive your bonus, you contribute 7% of the $250,000 bonus to your retirement plan for a total of $18,958 in contributions. However, you only received the employer match on the $1500 that you contributed in January plus the portion that you contributed from regular wages in February. Looking further down the road, assuming you continue to contribute the same percentage of your pay with each pay period, you will have reached the maximum personal deferral amount of $23,000 by the end of May. But, only $5,500 of your $23,000 contributed was eligible for company matching contributions. Or if your company matches 5% of your contributions, you’ve missed out on $875 (5% of the $17,500 contributed from your bonus). 

How do you fix this?

There are a few ways to fix this but the options available will depend on your employer. Some employers will allow you to opt out of making contributions from your bonus. In this case, you would spread your $23,000 in contributions based on your salary throughout the year and receive the company match on all of those contributions.

Another option is to reduce your contribution percentage on your plan provider’s site down to 0 for the pay period that includes your bonus and then reset the contribution percentage back to the amount that will allow you to meet your annual objectives. Before taking this route, be absolutely sure that you understand how and how often you can change your contribution percentage elections. If you can only make changes on a quarterly basis, this may not be the best option.

Another option depends on whether your employer allows non-Roth after-tax contributions and in-plan Roth conversions. Non-Roth, after-tax contributions to your retirement plan do not count towards the annual deferral limit that applies to pre-tax and Roth contributions. In this scenario, you are not maxing out your annual deferral limit, which could cause you to lose matching dollars on your pre-tax and Roth contributions later. Also, assuming your plan allows in-plan Roth conversions, you have the opportunity to get more dollars into your designated Roth account in your 401k by converting the non-Roth after-tax contributions to Roth dollars.

FAQ

What if my employer does match contributions from my bonus?

Then, you shouldn’t run into this problem because the employer will match all of your pre-tax and Roth contributions, and you should be able to take full advantage of the matching contributions.

Should I use the non-Roth, after-tax option even if I’m already getting the full employer match?

Perhaps. This can be a good option if it aligns with your ultimate goals. Be sure to determine whether your plan offers in-plan Roth conversions or in-service distributions.

Where do I find out if my employer matches contributions from my bonus?

To confirm your plan’s matching formula and the types of contributions that can be made (pre-tax, Roth, non-Roth after-tax), request a copy of the Summary Plan Description from your human resources benefits department. In some cases, the document may be available on your plan provider’s website.

What if my bonus is at the end of the year?

If your bonus is awarded at the end of the year, it is less likely that your bonus will cause you to max out the personal deferral limit. And, if you do max it out, you likely will have received the bulk of the company match already throughout the year. However, year-end bonuses are more of a challenge when it comes to tax and income planning.

This article is intended to be educational and thought-provoking rather than financial advice. When we work together in a financial planning engagement, we discuss your unique personal situation and your unique goals. We examine these factors and many others during our financial planning process to determine appropriate financial strategies for YOU.

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